McCall’s Call: Time For Emerging Bond ETFs

September 09, 2011

With all the volatility in markets, now’s a great time to take a closer look at emerging market debt ETFs.

 

As equities around the world continue to move lower amid extreme volatility, investors are searching for more stable investment options. They need look no further than emerging markets debt for one of the more promising areas.

Matthew D. McCallTo be sure, emerging markets equities have struggled as the developed world deals with debt and political issues. The iShares Emerging Markets ETF (NYSEArca: EEM), for example, is down 11 percent year-to-date, lagging major U.S. indexes. This is largely because investors still perceive high-growth developing countries as risky.

Emerging market bonds are often lumped into the same bucket as emerging market stocks. But just because the name of the fund includes “emerging markets” doesn’t indicate risk. Do you consider fiscal situations in Brazil or Indonesia riskier than in the eurozone? I hope not.

Consider, for example, that the debt-to-GDP balance in emerging markets is less than 40 percent—compared with nearly 100 percent or 200 percent in developed nations like the U.S. and Japan, respectively. Moreover, emerging markets offer, in general, higher yields than comparable developed-market bonds.

Additionally, while risks in many emerging market countries can vary widely—from political, regulatory or even currency related—it’s not like Europe and the U.S. are paragons of smooth governance and order these days.

Regarding currency risk, investors have two broad options when it comes to emerging market bond ETFs—those with dollar-denominated holdings and those issued in local currencies.

Investors currently can choose among four broad emerging market debt funds—two denominated in dollars and two denominated in local currencies.

Choosing The Right ETF

The older two funds are the ones holding their bonds in dollar terms.

Those are the PowerShares Emerging Markets Sovereign Debt ETF (NYSEArca: PCY) and the iShares JPMorgan USD Emerging Markets Bond ETF (NYSEArca: EMB). They benefit from a strong dollar when the returns are calculated.

The two ETFs denominated in local currencies—which have enhanced returns when the dollar weakens—came to market in the summer of 2010.

They are the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) and the WisdomTree Emerging Markets Local Debt ETF (NYSEArca: ELD).

 

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