Record Inflows Favor Emerging Market Bond ETFs

I’ve written a number of features on “money flow” in the recent past, incorporating daily data at the Wall Street Journal and/or weekly directionality reported by the research firm EPFR Global. In fact, one month ago, I identified the enormous amount of money that was “flowing” into emerging market equities and emerging market bonds.

Four weeks has since elapsed. And, in spite of the psychological Dow 10,000 “victory,” EPFR Global reports that net assets have actually been leaving U.S. equities. Meanwhile, money market funds have not been the beneficiaries of the reported outflow.

Since the money has to flow somewhere, where have the dollars/yen/euros presumably gone? Yep… still heading into the hot emerging market stocks and equally desirable emerging market bonds.

Half of net inflows are accounted for in emerging market equities. Yet it’s still probable that a developed market sell-off would adversely affect emergers in the near-term; moreover, precious metals may be a preferred method for how a portoflio may maintain its purchasing power.

This leads me to the most critical stat in the fund flow data; emerging market bonds raked in nearly $1 billion in a single week… the largest weekly haul on EPFR’s record books.

So far, ETF investors have limited choices in emerging market bond investing. Here are 3 of the most popular trade-able funds:

1. PowerShares Emerging Market Sovereign Debt (PCY). Ever since its inception, its been one of my favorite diversifers. (Review my 11/2007 feature on why PCY may be the perfect hedge.)

Other than the worldwide liquidation of all asset classes in the credit collapse 9/08-11/08, PCY has delivered the goods. Year-to-date, PCY is up a startling 31% and remains comfortably above short- and long-term trendlines.

2. iShares JPMorgan USD Emerging Markets Bond Fund (EMB). The coupon yield here is close to 7%, while the SEC 30-day yield is 5.5%. Some folks might think it may not be the best yield for a weighted average maturity of 12 years when you have heavy exposure to Russian and Latin American debt. On the flip side, EMB continues to demonstrate demand via 11% YTD gains and a current price above its 200-day trendline.

3. Templeton Emerging Markets Income (TEI). For starters, TEI is not a traditional ETF, but rather, a closed-end fund that trades on an exchange. Prospective investors want to consider the pros and cons of CEFs versus ETFs.

Still, TEI is not a dollar-denominated fund like the 2 mentioned earlier. This means TEI can take advantage of dollar weakness… or at least act as a hedge against the falling dollar. It currently yields 7%, and has a bit lower average credit quality than PCY or EMB.

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Comments

[ilc:]

Since PCY and EMB are dollar-denominated, and the easy gains are gone, why would one buy them? Just for the yield? They provide no protection against the Fed's ongoing USD depreciation.

Of course, the latter point may also mean that they carry little default risk (a new era where strong Emerging economies have no trouble scrounging up USD to pay off USD-denominated bonds). If PCY and EMB yield 5-6% and are safer than most people realize, I can see the appeal.

Oct 23 09:26 AM

[Mad Hedge F...:]

vve A number of readers have asked me tocome up with a safe, high yielding investment in which to hide out incase the equity markets swoon again. That means they are looking for a security that offers a high fixed return, denominated in a strong currency that will benefit from future upgrades that will boost theprincipal over time. All of that is another name for the Invesco PowerShares Emerging Market Sovereign Debt ETF (PCY). The fund has 40%of its assets in bonds issued in Latin America and 31% in Asia, with the bulk of the maturities exceeding ten years. The two year old fund now boasts $340 million in market cap and pays a handy 6.42% dividend.This beats the daylights out of the nine basis points you currently earn for cash, the 3.40% yield on 10 year Treasuries, and still exceeds the 6.42% dividend on the iShares Investment Grade Bond ETN (LQD),which buys predominantly single “A” US corporates. The big difference here is that have a rosy future of further creditup grades to look forward to. It turns out that many emerging markets have little or no debt because until recently, investors thought theircredit quality was too poor. No doubt a history of defaults in Brazil and Argentina in the seventies and eighties is at the back of theirminds. With US government bond issuance going through the roof, the shoe is now on the other foot. A price appreciation of 125% over the past year tells you this is not exactly an undiscovered concept. Still,it is something to keep on your “buy on dips” list.

Oct 23 12:01 PM

[market mojo:]

RE: PCY

"The fund normally invests at least 80% of total assets in emerging markets U.S. dollar-denominated government bonds. It may invest at least 90% of total assets in the securities that comprise the DB Emerging Market USD Liquid Balanced index. The fund is nondiversified."

Doesn't seem like a good dollar hedge to me.


On Oct 23 12:01 PM Mad Hedge Fund Trader wrote:

> vve A number of readers have asked me tocome up with a safe, high
> yielding investment in which to hide out incase the equity markets
> swoon again. That means they are looking for a security that offers
> a high fixed return, denominated in a strong currency that will benefit
> from future upgrades that will boost theprincipal over time. All
> of that is another name for the Invesco PowerShares Emerging Market
> Sovereign Debt ETF (seekingalpha.com/symbo...). The fund
> has 40%of its assets in bonds issued in Latin America and 31% in
> Asia, with the bulk of the maturities exceeding ten years. The two
> year old fund now boasts $340 million in market cap and pays a handy
> 6.42% dividend.This beats the daylights out of the nine basis points
> you currently earn for cash, the 3.40% yield on 10 year Treasuries,
> and still exceeds the 6.42% dividend on the iShares Investment Grade
> Bond ETN (seekingalpha.com/symbo... buys predominantly
> single “A” US corporates. The big difference here is that have a
> rosy future of further creditup grades to look forward to. It turns
> out that many emerging markets have little or no debt because until
> recently, investors thought theircredit quality was too poor. No
> doubt a history of defaults in Brazil and Argentina in the seventies
> and eighties is at the back of theirminds. With US government bond
> issuance going through the roof, the shoe is now on the other foot.
> A price appreciation of 125% over the past year tells you this is
> not exactly an undiscovered concept. Still,it is something to keep
> on your “buy on dips” list.

Oct 23 12:26 PM

[Jake2:]

Of some interest possibly:
NEW YORK (Dow Jones)--J.P. Morgan (JPM) revised its outlook on the technical environment for emerging-market external debt to negative from neutral.

"Overall positions are approaching record highs and cash balances have declined 0.2% to 4.8%, but still remain relatively high due to continued inflows," which year-to-date are $12.7 billion, noted Joyce Chang, global head of emerging markets research at JPMorgan in New York.

Moreover, emerging-market sovereigns have now completed 94% of the expected $65.5 billion of 2009 issuance, according to Chang.

Now, investors are reducing risk in countries where central banks have already or are indicating a more active involvement in preventing excessive foreign exchange appreciation, such as Brazil, Israel and Czech Republic, she said in a research note.

Oct 23 02:01 PM

[Plant the s...:]

There may be a secular change in the funding of Emerging bonds given the income gains over the past decade, such that they are self-financing versus seeking external funds.
The ETFs are probably just piling onto an improving domestic investment climate in the emerging world.

Nov 05 02:17 PM