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Emerging Market Currency Bond ETFs: Safe Haven/Risky Bet?

Zacks Equity Research

The global market rout is nearing its peak and the U.S. treasury bonds are drawing attention with investors seeking refuge to safe havens. However, this strategy earns investors safety in their portfolio but deprives them of high yields. 

Previously, emerging market currency bonds and the related ETFs were shelters for investors seeking juicy yields as well as relatively higher protection to capital gains. But they seem to have lost their appeal now.  

There are a plenty of reasons that are pushing this investing arena out of favor. Below we highlight what’s spoiling the fervor in emerging market currency bond ETF investing and marring its safe haven appeal.

Why A Risky Bet Now?

Stronger Dollar: First of all, several emerging market currencies have been facing tough times in recent months and stacking up losses due to a still strong U.S. dollar. WisdomTree Emerging Currency Strategy ETF (CEW), which measures changes in the value of emerging market currencies relative to the U.S. dollar, is down over 10% this year and lost 8.8% in the last three months (as of September 9, 2015).

The speculation for the Fed lift-off has never been as strong as it is this time around. Though U.S. job numbers in August grew at the most sluggish pace in 5 months and fell short of analysts’ expectation, this might not deter the Fed from finally hiking the rate. This has made the greenback a king of currency that has weighed heavily on a basket of emerging market currencies, be it across Asia, or Latin America.

Slumping Commodities: Many emerging market nations are commodity-rich. As a result, a broader commodity market swoon on supply glut, lower demand on global growth worries and a strong greenback wrecked havoc on currencies of commodity-focused economies including Russia, Brazil and Columbia.

This was truer given the oil price crash over more than the last one-year period which has wrecked havoc on oil-oriented emerging economies like Russia and Columbia. This also dealt a blow to the emerging market currencies (read: 2 Emerging Market Currency ETFs Crushed by Oil Rout).

China-Induced Global Market Rout: Upheaval in the Chinese economy and the stock market crushed the global market in August and it is still not out of woods. This episode sent shockwaves to other emerging markets, making the economic health of the entire EM bloc questionable.

Impact on Emerging Market Currencies

As a result, global emerging market bonds were hit hard at the last week of August and saw the highest exodus in assets (worth about $4.2 billion) since the taper threat in 2013. Several analysts like Societe Generale are against the emerging market currency bonds and believe that even if the Fed holds up the lift-off at the current level keeping the global market turmoil in mind, sheer ambiguity in policy decision will likely keep the outlook of the emerging market currencies downbeat.

In short, underperformance in currency has marred the appeal for higher yields in emerging market bond ETFs. The recent price performance also bore testimony to this fact. Fundamental Emerging Markets Local Debt Portfolio (PFEM) was the weakest performer in the emerging market debt ETF pack while the U.S.-dollar denominated ETFs like Emerging Markets Sovereign Debt Portfolio (PCY) performed relatively better.

U.S. dollar-denominated bond ETFs invest in sovereign debt from various emerging nations, but do so via U.S. dollar-denominated securities and are thus not hurt by currency translation troubles (read: Guide to Local Currency Emerging Market Bond ETFs).

Some of the worst-performing emerging market currency bond ETFs in recent times are Market Vectors Emerging Markets Local Currency Bond ETF (EMLC), WisdomTree Emerging Markets Local Debt Fund (ELD), iShares Emerging Markets Local Currency Bond ETF (LEMB) and SPDR Barclays Capital Emerging Market Local Bond ETF (EBND) (see all emerging market bond ETFs here).

These ETFs shed the most in the last one-month frame, having lost in 5% to 7% range while retreated about 2% in the last five trading sessions (as of September 9, 2015). So, we can conclude from the recent trend that emerging market currency bond ETFs are hardly safe with attractive yields. Instead, these are rather unsafe with melting gains.

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