3 Countries Could Pressure EM Bond ETFs

by: Tom Lydon

Emerging market bonds exchange traded funds have exploded in recent years, attracting billions as investors sought new sources of yield. However, vulnerable currencies and small markets in some developing countries could put pressure on the broader bond funds.

Deutsche Bank singles out Malaysia, South Africa and Indonesia as potentially problematic areas that could put selling pressure on the retail side, reports Shuli Ren for Barron's.

Large mutual funds can affect the way some emerging market bond markets act. Mutual funds benchmark against the J.P. Morgan GBI-EM GLobal Diversified Index, which caps country weightings at 10%. Consequently, smaller countries have a larger weight in the index. When large emerging market bond funds sell, these smaller markets are typically more sensitive to the foreign capital outflows.

Additionally, the South African rand and Indonesian rupiah have depreciated over 20% against the U.S. dollar this year, turning away investors - a weaker foreign currency translates to lower investment gains when converted back into U.S. dollars.

The iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEARCA:EMB), which tracks U.S. dollar-denominated emerging market bonds, includes a 5.3% weight toward Indonesia and a 3.9% weight in South Africa. EMB has a 5.07% 30-day SEC yield.

The PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEARCA:PCY), which also tracks USD-denominated bonds, has a 5.16% 30-day SEC yield.

The WisdomTree Emerging Markets Local Debt Fund (NYSEARCA:ELD) is subject to currency risk as it holds local debt denominated in emerging market currencies. The fund includes exposure to Malaysia 9.8%, Indonesia 6.8% and South Africa 6.6%. ELD comes with a 5.38% 30-day SEC yield.

The Market Vectors Emerging Markets Local Currency Bond ETF (NYSEARCA:EMLC) also tracks local currency denominated bonds. Country allocations include South Africa 9.6%, Malaysia 8.6% and Indonesia 5.7%. EMLC has a 5.69% 30-day SEC yield.

Max Chen contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.