New Emerging Markets Bond Fund Targets Commodity Countries

TheStreet.com

NEW YORK (TheStreet) -- Seasoned ETF investors will be familiar Research Affiliates fundamentally weighted equity indexes as opposed to market cap weighted indexes. The PowerShares FTSE RAFI US 1000 Portfolio was the first fundamentally weighted equity ETF and has done very well since its inception compared to the SPDR S&P 500 .

Fundamental weighting has since been applied to many other equity funds and even a corporate bond fund and the latest fundamentally weight fund is the PowerShares Fundamental Emerging Markets Local Debt Portfolio . Instead of looking at things like cash flow and revenue in the equity funds, PFEM weights sovereign debt by country in the fund on the basis of population, GDP, energy consumption and land. Energy consumption is viewed as a proxy for economic activity and with land the methodology is concerned with a country's natural resources.

The word local in the name of the fund means that bonds owned will be denominated in the currencies of issuance as opposed to U.S. dollars. There are quite a few emerging market bonds funds that only hold U.S. dollar denominated debt including the PowerShares Emerging Markets Sovereign Debt .

PCY has been successful in terms of price performance and yield which has helped the fund grow to $2.6 billion in assets. On the surface the new PFEM and PCY would seem to be competing with each other. The difference of course is PFEM does take on currency fluctuation and PCY does not, however a dramatic swoon in a currency would affect the price of a dollar denominated bond.


The largest country weighting in PFEM is Russia at 11% followed by Brazil at 10%, Indonesia and Mexico at 8% each and South Korea at 7% before getting smaller from there. PowerShares reports that the effective duration of PFEM is 5.61 years which means that the fund should not be overly sensitive to rising interest rates, interestingly the effective duration for PCY is much longer at 9.6 years.

While it is still too early for any yield information for PFEM, as an indication PCY shows a trailing 12 month yield of 4.17% but with PFEM's shorter maturity its yield could be slightly lower.

For the last three months the U.S. dollar has gone up against most of the currencies captured in PFEM. The dollar is up about 4% each against the Russian ruble and Brazilian real. A slow appreciation of the dollar will be a drag on PFEM and the trend is actually longer than three months. For the last two years the dollar is up 11% against the ruble and 25% against the real. This coincides with general under performance of resource related stocks and commodities.


This does not make PFEM a bad fund. Actually it is a good thing that the risks are relatively easy to isolate. At some point the downtrends in commodity related securities and the respective currencies will turn higher and when they do PFEM will be a good hold but until investors will be better off with PCY.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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