Investors eagerly ditched emerging markets bonds exchange traded funds in 2013 as the specter of an end to easy money from the U.S. forced some developing world currencies, exposing external financing vulnerability across the emerging world in the process.
Cash flowed steadily flowed out of emerging markets bond ETFs to the point that the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) was one of last year’s 10 worst ETFs in terms of annual outflows.
However, investors still have an appetite for emerging markets corporate debt. That much is confirmed by the fact that the actively managed WisdomTree Emerging Markets Corporate Bond Fund (EMCB) , the largest ETF holding developing world corporates, and the rival iShares Emerging Markets Corporate Bond ETF (CEMB) both saw inflows last year.
“Default rates are so far only creeping up, with a rate of 3.1 percent this year after 2.7 percent last year and 1.6 percent in 2010,” Reuters reported, citing J.P. Morgan data. The appetite for these bonds is robust “with 65 funds launched in 2012 and 2013, specifically to invest in emerging corporate debt,” according to data from Thomson Reuters company Lipper.
Russian corporates could be among the developing world’s most alluring, but as is usually the case with investing in Russia, there are risks. Perhaps in a sign of growing interest in Russian corporate debt, Bank of America Merrill Lynch recently included the country in its new Diversified Local Emerging Markets Non-Sovereign Index.
Backstopping some Russian corporate issues and mitigating default risk is the fact that many of the country’s largest issuers of corporate debt, including banks and energy producers, are state-controlled. That puts Russian corporates more in the quasi-sovereign category than in pure corporate territory. [The Potential Allure of Russian Corporates]
EMCB is not a junk bond ETF as about 58% of its holdings are rated BB, A or AA. The fund features a 31.4% weight to Russia, but more importantly a 30-day SEC yield of almost 5.1% compared to 3.43% on the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD).
Another important issue to consider with ETFs such as EMCB is sector exposure. David Spegel, head of emerging debt strategy at ING Bank, told Reuters that nearly two-thirds of developing world corporates bond issuance comes from energy and materials companies that have hard currency revenue hedges in place. With Russia, Brazil, Mexico and Colombia combining for almost 80% of EMCB’s country weight, it is not surprising that Oil, metals and materials issue represent a combined 59% of the ETF’s weight.
EMCB outperformed EMB last year as emerging markets companies sold $345 billion in debt.
WisdomTree Emerging Markets Corporate Bond Fund
ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of EMB and LQD.
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.