Over the past few years, I've written repeatedly about the
compelling long-term opportunities presented byemerging markets .
These economies possess superior long-term growth prospects but
trade at a considerable discount to more mature markets in Europe
and the United States.
Still, it's hard to understate the importance of "long-term"
in that outlook. Emerging markets are quite volatile and can
quickly rack up short-term losses. Indeed, in recent weeks a
number of emerging markets have tumbled sharply, in large part
due to concerns of an economic slowdown in China that is
dampening demand for exports in countries such as Australia,
Brazil and South Africa. I wrote about theissue in this recent
For a while there, global investors were dumping
emerging-marketbonds just as fast as they were selling
emerging-marketstocks . Then a light bulb went off: Investors
realized that bonds are alot safer in a slowingeconomy -- for a
pair of reasons.
Those two factors: strong government finances and a lack
ofcurrency risk .
Back in the 1970s and '80s, many emerging-market governments
showed little competence when it came to managing their
finances.Cash reserves often ran dry, and panics ensued.
Moreover, emergingmarket finance ministers typically pursued
populist spending policies, which eventually led to high rates
ofinflation due to poor resource allocation.
Over the past few decades, much has changed. Today's finance
ministers often are selected based on their global economic
experience, having served stints at places such as theWorld Bank
or theInternational Monetary Fund (
) . These officials now ensure that government cash levels are
quite robust, and they take steps to beat back inflation whenever
it emerges. Morningstaranalysts note , "Today, many emerging
markets have relatively favorable growth outlooks, healthy
balance sheets, budget surpluses, and favorable
A key result: We saw manygovernment bond defaults back in the
bad old days, but in the past few decades, Argentina is the only
major economy todefault on its bonds. That aspect of risk in
government bonds has been virtually wiped out.
Still, U.S. investors suffer whenever the dollar strengthens
against other currencies, and that has been a bigfactor in recent
losses in emerging market stocks. Bonds don't always carry such
currency risk. Many emerging-market government bonds (known as
"sovereigns") are denominated in dollars.
Even with a recent rebound, emerging-market bonds have fallen
roughly 10% in just a couple of months, which has pushed already
impressive yields into high-yield territory. That makes this a
fine time to give these three exchange-tradedfunds (
) a closer look.
1. iShares JPMorgan USD Emerging Markets Bond (
Each of the 163 bonds in this portfolio is denominated in
dollars, led by stakes in Russian, Brazilian, Turkish and Mexican
bonds. The 30-dayyield of 4.8% (as calculated by the Securities
and ExchangeCommission ) is more than twice the yield you'll get
from afund focused on U.S. government bonds. Back in early May,
that yield stood at just 3.6%.
2. Vanguard Emerging Markets Government BondIndex
ETF (Nasdaq: VWOB)
As a Vanguard fund, thisETF is a typically good deal: The 0.35%
annualexpense ratio leads the pack. This fund also only buys
dollar-denominated bonds with a leading focus on Brazil, Russia,
Mexico and Turkey. This fund was launched only a month ago, and
Vanguard has yet to denote the 30-day SEC yield; look for it to
fall in the 4% to 5% range.
3. WisdomTree Emerging Markets LocalDebt (
Some investors prefer to retain currency risk, especially after
the dollar has made a strong run, as it has recently. Any
pullback in the dollar, and corresponding rebound for other
currencies, would actually magnifygains for these bonds. For such
investors, this ETF should hold great appeal, as the bulk of its
bonds are denominated in local currencies.
The fund's managers have taken an unusual approach, allocating
roughly 40% of the fund to four countries that receive
investment-graderatings , another 40% to midtier-rated government
bonds, and the remainder in riskier yet higher-yielding bonds.
Malaysian, Indonesian, Mexican and Brazilian bonds make up the
top four holdings. The 30-day SEC yield of 4.7% nearly matches
the iShares JPMorgan ETF noted above.
4. Market Vectors Emerging Markets LocalCurrency
Bond ETF (Nasdaq: EMLC)
Like the WisdomTreebond fund , this ETF also has exposure to
local currencies. The appeal here is a relatively high 5.5%
30-day SEC yield and a fairly low 0.47% expense ratio. Poland,
Brazil, South Africa and Turkey make up the top holdings interms
Risks to Consider:
Emerging-market bonds fell a whopping 30% in 2008, more than
twice the current pullback, though that was considered to be a
unique economic era that is unlikely to repeat.
Action to Take -->
The key distinction between these four ETFs is the currency
exposure. Further global economic weakness thisyear could lead to
an ongoing "flight to quality " into the U.S. dollar, which would
hurt the returns of local currency bonds. But over the longerterm
, global trade flows suggest that the dollar is bound to decline
over time, which would serve to help boost returns of the bonds
denominated in local currencies.