Robust Demand Could Lift EM Bond ETFs

ETF Trends

Emerging markets bond exchange traded funds are looking to rebound in 2014 after being one of last year’s most repudiated ETF segments.

Amid soaring new issuance, dollar-denominated emerging markets debt funds are off to decent starts this year and it is that surge in issuance that underscores the notion of investors remaining committed to developing world debt.

Since the start of 2014 “emerging-market sovereigns have sold almost $19 billion of bonds, three times what was sold at this stage last year and the fastest start to a year since 2000,” Ben Edwards reports for the Wall Street Journal. Eastern Europe, home to low funding costs, is driving the brisk pace of new issuance, according to the Journal.

The iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) was one of the 10 worst ETFs in 2013 in terms of outflows and EMB and the rival PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) lost an average of 9%. Since the start of this year, EMB and PCY are each up about 1%. As of Jan. 14, PCY had seen 2014 inflows of almost $8.2 million, according to PowerShares data.

In recent weeks, Poland, Slovakia, Latvia and Romania have been among the most active issuers of new debt, the Journal reported.  Latvia, Romania and Poland combine for about 14% of PCY’s weight and are three of the ETF’s top-six country allocations. The ETF also features four other Eastern European nations among its top-10 country weights. [Punishment Could Become a Gift for EM Bond ETFs]

Eastern European nations sold $47 billion in sovereign debt last year, but that number could rise to $50 billion this year, the Journal reported, citing Standard Bank.

EMB has an effective duration of almost seven years. That is not necessarily “long duration,” but it is enough to have highlighted the vulnerability of the ETF to rising interest rates. [EM Bond ETFs Look to Better 2014]

“Over the years as investors have become more comfortable with emerging-markets bonds, issuers have lengthened the average maturity of their issues to 10-20 years. The ETFs in this group have average durations between 7 and 9 years, so if interest rates rise substantially, the long duration of these bonds will likely cause high volatility and negative returns,” according to Morningstar analyst Timothy Strauts.

Assuming a legitimate rebound in dollar-denominated emerging markets sovereign debt materializes, a short duration option for investors to consider is the newly-minted ProShares Short Term USD Emerging Markets Bond ETF (EMSH). EMSH has a 30-day SEC yield of 4%, but its modified duration is just 2.17 years.

iShares J.P. Morgan USD Emerging Markets Bond ETF

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ETF Trends editorial team contributed to this piece. Tom Lydon’s clients own

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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