Emerging Market Bond ETFs: Time to Buy?


With the U.S. economy coming back stronger than most in 2013, the focus of many investors has been on the domestic market. This trend isn’t exclusive to the equity world either, as a number of bond ETFs targeting Treasury securities have also seen solid inflows to start the year.

Largely, this push has been thanks to a strong dollar and concerns about a variety of developed and emerging markets around the globe. Many key nations like Britain, China, Brazil, and France, have all seen a bout of weakness while the dollar’s strength has dulled the repatriated value of overseas gains as well (Read Buy These ETFs to Benefit from Japan’s Massive Easing).

Still, many are growing more optimistic about emerging markets, as many of these quickly-growing nations remain on a solid growth track. And, from a fixed income perspective, most emerging markets have low debt loads and reasonable discount rates, suggesting that they are well-positioned for the years ahead no matter what the future brings.

Dollar-Denominated Bond ETFs in Focus

Thanks to these positive trends, but the continued presence of a stubbornly strong dollar, investors who are thinking of making a more global play for their fixed income could be well served by looking at dollar-denominated bond ETFs. These funds invest in sovereign debt from a variety of emerging nations, but do so via U.S. dollar-denominated securities.

This approach eliminates the currency risk that can be a huge hazard in the emerging bond world, while still exposing investors to the strong balance sheets of these nations. And since many of these nations remain below-investment grade—despite the relatively strong positions of their economies—yields look to be elevated when compared to similar bonds for developed market nations (see Buy These Bond ETFs for Income and Diversification).

Given these positives, it could be time to look at emerging market dollar-denominated bond ETFs for exposure. This is especially true given that two of the most popular funds in the space have been seeing strong technicals as well.

In fact, two of the biggest ETFs in this space have both seen their 15 day simple moving averages cross above their longer term 200 day moving averages. This suggests that short-term bullishness is ahead for the space possibly signaling that it could be time to take a closer look at either of these well-positioned ETFs:

PowerShares Emerging Markets Sovereign Debt Portfolio (PCY)

This ETF invests in just under two dozen emerging market sovereign bonds, offering diverse exposure across the globe. Countries from around the world are represented, including roughly one-third in Latin America, another third in emerging Europe, and the rest across Asia, the Middle East and Africa.

Credit exposure is heavily skewed towards the ‘BBB’ level so there is some risk there, although the interest rate risk is moderate. On this front, the effective duration is roughly 9.5 years, putting PCY in the middle part of the curve (read 3 Excellent ETFs for Income Investors).

In terms of yield though, the ETF sees a SEC 30 Day payout of about 3.7%, while costs come in at 50 basis points a year. The fund is still down about 1.5% so far in 2013, though it has come back a bit in recent weeks, adding about 1.1% in the trailing one month time frame.

iShares Emerging Markets USD Bond ETF (EMB)

This ETF looks to track the J.P. Morgan EMBI Global Core Index, a benchmark of U.S. dollar denominated emerging markets debt. This index also looks to limit the weights of nations with higher debt outstanding, and then reallocate this excess to countries with lower levels of debt outstanding, hopefully tilting the portfolio to safer nations in the process.

This results in a portfolio that is also well-diversified across continents, with Latin America and Europe accounting for roughly one-third of the assets, and the rest going to Asia, the Middle East and Africa. However, unlike PCY, this ETF is a bit more concentrated, putting roughly 6.7% in nations such as Russia, Brazil, and Turkey.

For a 30 Day SEC Yield, the fund pays out roughly 3.6% to investors, while costing about 59 basis points a year in fees. In terms of performance, this fund has also lost about 1.5% in the year-to-date time frame, while it too has come back in recent trading, adding about 0.7% in the last month.

Bottom Line

Both PCY and EMB present compelling values at this time thanks to their strong yields and exposure to well-positioned countries. Plus, their spread out holdings insures that no single country will bring down the fund or cause big issues for the total return picture (read 4 Best ETF Strategies for 2013).

Best of all though, both of these ETFs are dollar-denominated so there aren’t any currency risks in these products. So if the dollar remains strong, these ETFs could outperform their local-currency cousins, while still offering up solid exposure to the resurgent story in the emerging world.

This could be an ideal combination for many investors, and especially those who are overexposed to U.S. Treasury investments at this time. So if you are in the market for a new bond ETF, definitely consider PCY or EMB for lower risk exposure to the emerging market world in today’s strong dollar environment.

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