For a significant portion of this year, emerging markets bond exchange traded funds have been a hot area of the fixed income ETF space. For example, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca:EMB) is one of this year’s top asset-gathering ETFs. In fact, only one bond ETF has added more new assets than EMB.
However, some analysts are encouraging investors to monitor growing current account deficits (CADs) in emerging markets and how those deficits could affect issuers’ ability to finance dollar-denominated debt, such as the debt found in ETFs like EMB.
“Emerging markets last year ran their first aggregate annual current account deficit (CAD) for 17 years – and their largest since 1998 (both in US dollars and as a percentage of GDP). The deterioration has been driven mainly by a drop in commodity prices, a narrowing in China’s surplus, and the effect of abundant global liquidity conditions. We forecast the aggregate EM CAD will widen further in 2017 to its highest level in US dollar terms since at least 1990,” according to Fitch Ratings.
EMB tracks the J.P. Morgan EMBI Global Core Index, a market-cap-weighted index. Potential investors should note that since it is a cap-weighted index, countries with greater debt will have a larger position in the portfolio. EMB is now the world’s largest emerging markets bond fund, ETF or mutual fund.
The PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEARCA:PCY), another dollar-denominated ETF, is another emerging markets bond ETF to consider. PCY is the second-largest dollar-denominated emerging markets bonds ETF behind EMB.
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A U.S. dollar-denominated investment grade sovereign emerging market bond strategy may also help investors focus on higher quality assets and avoid the volatility associated with emerging market local currencies while gaining exposure to high credit quality.
“However, within the EM total, current accounts have become more balanced since 2013 as the deterioration mainly reflects Gulf Cooperation Council (GCC) countries, which were previously running large surpluses, while many countries then running large CADs, such as all of the so-called ‘fragile five’ (Brazil, India, Indonesia, South Africa and Turkey), have narrowed their deficits. The median CAD for Fitch-rated EMs rose to 3.3% of GDP in 2016 from 2.5% in 2013. We forecast 20 EM to run CADs of over 5% of GDP this year, with half of them in double-digits,” according to Fitch.
For more on bond ETFs, visit our fixed income category.