Taper Talk Pummels Local Currency Bond ETFs

ETF Trends

Emerging markets bond ETFs that hold debt issues denominated in local currencies were one of last year’s hottest asset classes. Investors rushed into these funds to satisfy their thirst for yield and that move was supported by the Federal Reserve’s ultra-loose monetary policy.

The world is a different place today. Price action by and sentiment toward local currency emerging markets bond ETFs is far removed from where it was last year. Fears, which could be imminently realized, that the Fed will begin paring its bond-buying have forced Treasury yields higher and bolstered the U.S. dollar, a toxic combination for bonds denominated in developing world currencies. [With Fed Meeting Looming, Sep-Taper Fears Rise]

Strong U.S. economic data points out Thursday fueled speculation that Fed could begin tapering before the end of this month. That sent the WisdomTree Emerging Markets Local Debt Fund (ELD) and the Market Vectors Emerging Markets Local Currency Bond ETF (EMLC) to new all-time lows.

In just the past three months, both ETFs are down about 9% and their descent to new lows comes as investors are not being shy about pulling cash from developing world bond funds. Barclays data show over $2 billion was pulled from emerging markets bonds ETFs during the last week of August, up from $1.3 billion in the prior week. [Emerging Markets ETFs Stung by Outflows]

Country allocations partially explain the tough times these ETFs have experienced this year. The actively managed ELD allocates over 27% of its weight to Indonesia, Brazil and Turkey, homes to three of the emerging world’s most battered currencies. The South African rand, Brazilian real, Turkish lira and Indonesian rupiah combine for 33.5 percent of EMLC’s weight, providing an answer as to why that ETF has struggled. [Indonesia ETFs Lead Global Sell-Off]

In fairness to ELD and EMLC, these are not the only emerging markets bond ETFs that have been struggling. The dollar-denominated PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) has also lost 9% in the past three months as investor fears of sovereign debt downgrades in the developing world have jumped.

Although ETFs such as ELD, EMLC and PCY are beaten up, history has shown that when emerging debt slumps in a given quarter, the following quarter is usually more kind. Some reversion to the mean could be exactly what the doctor ordered for emerging markets bonds as an assets class.

Market Vectors Emerging Markets Local Currency Bond ETF

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ETF Trends editorial team contributed to this post.

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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