Equity-based emerging markets ETFs have languished through
some rough performances in 2013, but their bond counterparts have
tumbled mightily as well.
That goes for both dollar-denominated and local currency
developing world debt. Year-to-date, the iShares J.P. Morgan USD
Emerging Markets Bond ETF (NYSE:
) is down eight percent, a loss that is nearly twice as bad as
that of iShares MSCI Emerging Markets ETF (NYSE:
"In the three months ending in July, local
currency-denominated EM sovereign bonds fell 10.6%, U.S.
dollar-denominated EM sovereign bonds declined 7.8%, and U.S.
dollar-denominated EM corporate bonds dropped 5.8%., according to
research note published last month by PIMCO
, the world's largest bond manager.
The specter of a reduction of or outright end to the Federal
Reserve's quantitative easing forced many emerging markets
currencies lower and bond yields higher, damaging local currency
bond ETFs in the process. However, there are signs the
environment for those ETFs could be improving.
Finally, Some Hope For EM Bond ETFs
"The possibility of a decline in the pace of Fed bond buying
was cited as the primary catalyst for currency weakness and
surging bond yields in emerging markets. Economies that once
benefited from foreign investor flows have underperformed since
flows began to reverse,"
said WisdomTree portfolio manager Rick Harper
in a new research note. "However, we believe that those moves had
overshot. With the recent FOMC meeting serving as a catalyst, we
believe that locally denominated fixed income appears as an
attractive way to play a less 'hawkish' Fed."
A more sanguine tapering environment should be a boon for ETFs
like the WisdomTree Emerging Markets Local Debt Fund (NYSE:
), the first actively manage ETF to cross the $1 billion in
assets under management level. Underscoring the vulnerability of
emerging markets local currency debt due to tapering talk, ELD
has performed slightly worse than EMB this year, losing 8.5
ELD offers exposure to Brazil, Chile, Colombia, Mexico, Peru,
Poland, Turkey, South Africa, Russia, Malaysia, Indonesia,
Philippines, Thailand, China, and South Korea. The ETF's
allocations to some of the most beaten-up developing world
currencies is high as Brazil, Turkey, Thailand and Indonesia
combine for about 31 percent of ELD's weight.
What is noteworthy about the taper-driven declines suffered by
emerging markets debt is that many of those bonds wound up
sporting higher yields than U.S. corporate junk.
"With some emerging markets being upgraded as recently as May
2013, we believe that only a select few pose a risk of a credit
rating downgrade. However, EM local debt was recently offering
the largest yield advantage compared to U.S. high yield in
history," said Harper.
That yield spread might imply creditworthiness issues with
emerging world issues, but ELD's lineup
hows that problem is likely overstated
. Roughly 49 percent of the ETF's holdings are rated AAA, AA or A
and another 25 percent are rated BBB.
Of ELD's country holdings, only Brazil looks
like a plausible candidate
for a ratings downgrade, but even that is something of a stretch
and it is not likely the country would be slapped with a junk
rating. At least not anytime soon.
Perhaps worst case scenarios that will not come to pass have
been priced into emerging markets debt, making ETFs like ELD
attractive opportunities at current levels.
"Ultimately, we believe EM local debt is attractively priced
at current levels. However, there is always the possibility that
market volatility may persist as the U.S. struggles to provide
appropriate guidance on the future path of interest rates. At
current yields, we believe that EM local debt provides an
attractive level of carry that may help dampen future volatility
associated with locally denominated fixed income," said
For more on ETFs, click
Disclosure: Author does not own any of the securities
(c) 2013 Benzinga.com. Benzinga does not provide investment
advice. All rights reserved.
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