Is the Party Over for High-Yield Emerging Market Bond ETFs?

ETF Trends

ETFs tracking dividend-paying sectors sensitive to interest rates such as utilities and REITs have been hurt by rising Treasury yields and talk the Federal Reserve may soon begin tapering its bond purchases.

Investors can also add emerging market bond ETFs to the list of recent casualties. The sector has been popular and performed well in recent years amid unprecedented stimulus from central banks around the world.

The largest ETFs in this category include iShares JPMorgan USD Emerging Markets Bond Fund (EMB), PowerShares Emerging Markets Sovereign Debt Portfolio (PCY), WisdomTree Emerging Markets Local Debt (ELD), Market Vectors Emerging Markets Local Currency Bond (EMLC) and SPDR Barclays Capital Emerging Markets Local Bond (EBND).

The local currency emerging market bond ETFs, such as ELD and EMLC, have fallen harder than the U.S. dollar-denominated funds recently due to the greenback’s strength. [Emerging Market Bond ETFs for Yield]

The pullback in developing market debt ETFs coincides with Fed chief Ben Bernanke saying the central bank was watching for signs of “reaching for yield” and other forms of excessive risk-taking. Bernanke has also hinted the Fed may ease back on its bond purchases if the economic and jobs data improves.

“The most glaring example of bubble-like tendencies is arguably to be found in emerging market bonds, where almost every new offering is met by insatiable demand,” the Financial Times reported last week.

Of course, rock-bottom interest rates have forced income-starved investors to take on more credit risk in search of yield. They have flooded into speculative-grade corporate debt and even substituted dividend-paying stocks in place of bonds.

Risky emerging market bond ETFs with higher yields have also been part of this trend. Yet the voracious demand for developing market debt has triggered bubble fears.

Next page: ‘Rally on steroids’

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