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Supply Overhang Could Hamper EM Bond ETFs


Exchange traded funds holding emerging markets sovereign bonds have struggled this year amid fears tapering of the Federal Reserve’s quantitative easing program would crimp developing markets dependent on external financing.

Investors’ repudiation of emerging markets sovereigns, once a favored asset class for income-starved investors, has sent the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) and the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) to an average year-to-date loss of 9%. EMB, the largest emerging markets bond ETF, is the eighth-worst ETF in terms of 2013 outflows with $2.66 billion in lost assets. [Investors Shun EM Bond ETFs]

While tapering fears have subsided and some emerging markets have dealt with current account deficits, a supply glut of developing world sovereigns could be a drag on EMB next year. Barclays expects emerging markets governments to issue a record $94 billion in hard currency for net supply (new issuance minus redemption) of $29 billion, more than double this year’s supply, according to Barron’s.

Mexico and Russia could issue a combined $20 while Indonesia, already grappling with the effects of a weak rupiah and current account deficit, could issue up to $8 billion in sovereign bonds, Barron’s reported.

Russia’s voracious appetite for debt issuance is not a surprise. Russia, which defaulted on its sovereign debt obligations in the late 1990s, said last year it plans to sell around $50 billion in government bonds per year through at least 2014. [The Allure of Russian Corporates]

Russia is EMB’s largest country weight, combining with Mexico and Indonesia for over 17% of the ETF’s weight. Russia is PCY’s ninth-largest country allocation at 4.45%. PCY also features decent exposure to countries, such as South Korea, Poland and the Philippines, that are less dependent on external financing. Those countries, all top-10 weights in PCY, combine for over 13% of the ETF’s weight.

PowerShares Emerging Markets Sovereign Debt Portfolio

ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of EMB.

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.