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EM Bond ETFs Face Another Russia Downgrade


Despite another tumultuous year for emerging markets equities, investors have remained confident regarding sovereign debt issued by developing world governments.

Last week, the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) and the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) took in almost $74 million combined, bringing year-to-date inflows to those ETFs to $1.1 billion and $377.5 million, respectively.

There have been some pitfalls along the way for emerging markets bond funds, including elections, geopolitical tensions and credit downgrades. Those ETFs with hefty exposure to Russia will have to contend with another downgrade to that country’s sovereign rating. Last Friday, Moody’s Investor’s Service pared its rating on Russian government debt to Baa2 from Baa1, the ratings agencies second-lowest investment grade.

EMB and PCY, the two largest emerging markets bond ETFs, have relatively light Russia allocations. Actually, PCY, the PowerShares offering, features no Russia exposure. EMB devotes just 5.4% to Russian bonds. [Diversify With EM Bond ETFs]

However, other emerging markets bond ETFs do have larger weights to Russia. There are some positives here. For example, these ETFs have been down this road before with Russia. In April, Standard & Poor’s lowered its rating on Russian sovereign debt to BBB-, the lowest investment grade. [Russia ETFs Fall After S&P Downgrade]

The ProShares Short Term USD Emerging Market Bond ETF (EMSH) featured combined allocation of nearly 19% to Russian and Ukrainian debt when S&P downgraded Russia in April. The ETF currently devotes 9.7% to Russian bonds, its largest country weight by 140 basis points over Indonesia.

Importantly, EMSH has fallen just 2% this year, a year in which Russia’s rating has been cut twice, Brazil’s once and investors have fretted about default in Venezuela. Brazil and Venezuela combine for 13.3% of EMSH’s weight. The ETF has a 30-day SEC yield of 4.72% and a modified duration of just 2.55 years, according to ProShares data.

The Vanguard Emerging Markets Government Bond ETF (VWOB) is another ETF that has traveled Russia Downgrade Boulevard this year. Only 22.2% of VWOB’s holdings were rated below Baa at the end of September and Russia is currently the ETF’s largest country weight at 10.4%. That is down from 12% at the time of the S&P downgrade. [Vanguard EM Bond ETF off to a Fine Start]

VWOB is up 3.7% this year despite Russia and Brazil combining for 20.6% of the fund’s weight. However, VWOB’s duration is more than double that of EMSH’s at 6.6 years. Home to 715 bonds, VWOB charges 0.35% year and has a yield to maturity of 5.1%.

ProShares Short Term USD Emerging Market Bond ETF