The financial services industry has dramatically changed over the past two decades. Service proliferation and technology innovation seem to have capitalized making a strong position in the market. Capital requirements are no longer relevant, thus investors are faced with very few, if any, barriers to stop them entering an asset class of their choosing. Initiating a position in an ETF utilizing a broad range of emerging market debt instruments is never a bad idea when uncertainty is high surrounding US markets. In today's financial industry, the issue facing many investors is simply a lack of knowledge for the underlying instrument, but specifically with regard to the instrument that will be discussed in this article, the uncertainty lies within the holdings. It this primary reason many inventors are worried and reluctant to initiate a position in PowerShares Emerging Markets Sovereign Debt Portfolio (PCY).
PCY is an exchange traded fund in nature, but differs from the every day ETF because it is a fund whose holdings are an emerging market debt portfolio fund. The returns of this fund are primarily based on the performance of the DB Emerging Market USD Liquidity Balance Index, which serves as the underlying index. In moderation, this index is a composition of emerging market U.S. dollar-denominated government bonds issued by approximately 22 different emerging market countries. Below is a graph illustrating PCY's five year performance. As you will see, PCY has provided a relatively stable return after gaining traction following the FY 2008 - FY 2009 credit crisis.
Figure 1: PCY 5-Year Price Graph from TDAmeritrade
As you can see in the figure above, PCY is currently trading at approximately $31.47 per share. The total asset value of the fund is roughly $3 billion and it compensates investors with a 4.69% dividend yield, or the equivalent $1.47 per share on an annual basis.
The constraint parameters in regards to PCY's holdings requires that at any given time there is to be a minimum of 80% of PCY's assets invested in bonds that are in the DB Emergin Market USD Liquidity Balance Index. Right now the net value invested into these assets is 99.68%, with the remaining 0.32% consisting of cash. As for the specific debt instruments that construct PCY's portfolio of holdings, the primary advantage derives from the fact that many of these emerging market bonds provide coupons in excess of 10%, while many comparable US government ETF's yield an average significantly lower ranging from 3% to 4%. Currently, there are approximately 64 securities that comprise the fund's holdings. The effective and modified duration are 9.41 and 9.21, respectively. To give investors with a more precise idea as to actually what individual fixed income securities PCY holds I have provided figure 2 below, which depicts PCY's top ten holdings as a percentage of its total assets.
Figure 2: PCY's Holdings from TDAmeritrade
Accounting for Risk
Market participants perceive there is a significantly higher risk associated with debt instruments issued by companies operating in emerging markets. While in some cases this theory may hold true, when it comes to PCY's holdings it does not. A large sum of PCY's holdings are debt issuance's from countries that contain many companies in excellent condition. Companies that have strong profit margins with adequate levels of liquidity and more importantly, that have extremely clean balance sheets. This indicates companies in these countries have the capability of paying debt holders. In some cases, these companies display far more capability of meeting required principal and interest payments than companies in developed countries.
Debt instruments such as bonds contain a unique attribute, in which their returns reveal an inverse relationship to those of the S&P 500. Overall, this indicates poor performance in equity markets will not necessarily result in the same for bond markets. An attribute, that bond portfolio enthusiasts love. In conclusion, PCY provides a unique opportunity that can provide further diversification to your portfolio helping offset the firm-specific risk associated with some of your favorite equity positions and serve as an asset that has the capability of withstanding unfavorable declines in equity markets.
Sources: TD Ameritrade, Investco PowerShares, The Wall Street Journal, & Google Finance.
Disclosure: I am long PCY.