Emerging Market Bond ETFs Closer To 'Risk-Free' Than U.S. Treasuries

by: Gary Gordon

The average debt-to-GDP ratio for developed world nations approximates 100%. In the United States, the ratio is close to 105% when one includes debt that is held in government accounts.

The average debt-to-GDP ratio in emerging market countries? Typically, you’re looking at something less than 40%. Without question, from a perspective of country credit, the emergers are far more capable of paying back the money that they borrow.

Of course, fear is quite adept at trumping fact. In the May-June swoon, investors dumped emerging market assets of all types, opting for the perceived safety of U.S. treasuries and the U.S. dollar.

Perhaps sensibly, investors did begin to take a second look at emerging market assets in the June-July quasi-recovery for risk assets. In fact, they’ve since pushed emerging market bond funds with their 5%-plus annual yields to 52-week highs.

Common Sense Favors Emerging Market Debt ETFs
PowerShares Emerging Market Sovereign (NYSEARCA:PCY) 7.9%
iShares JP Morgan USD Emerging Market (NYSEARCA:EMB) 6.7%
SPDR Barclays Emerging Market Local Bond (NYSEARCA:EBND) 6.1%
Market Vectors Emerging Market Local Currency (NYSEARCA:EMLC) 5.0%
WisdomTree Emerging Market Local Debt (NYSEARCA:ELD) 4.3%
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Of course, investors may not be as enamored with emerging market fixed income as they are with the yields they offer. We’ve seen ETFs for dividend stocks, preferred stocks, high yield bonds, investment grade corporates, business development corporations and mortgage REITs ride a similar wave.

It follows that additional flare-ups in the eurozone or hard landing China stories might see U.S. treasury bonds continue to gain and yields continue to log record lows. If that occurs, investors may foolishly sell emerging market bonds in frenzied trading, in spite of the fact emerging sovereign debt may be closer to “risk-free” than U.S. treasuries.

Less-Than-Sensible Love Affair With U.S. Treasury Bond ETFs
Vanguard Extended Duration Treasury Bond (NYSEARCA:EDV) 13.1%
iShares Barclays 20 Year Treasury Bond Fund (NYSEARCA:TLT) 9.0%
iShares Barclays 10-20 Year Treasury Bond (NYSEARCA:TLH) 5.7%
PowerShares Laddered 1-30 Treasury (NYSEARCA:PLW) 5.1%
iShares 7-10 Year Treasury Bond (NYSEARCA:IEF) 4.1%
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In sum, U.S. government debt is serving up yields that do not match inflation nor compensate investors for the level of indebtedness. With the above-mentioned 105% debt-to-GDP ratio, the likelihood of more Fed easing, and Congressional inability to tackle debt reform seriously, the only reason to purchase treasuries is to “bet” on a worldwide catastrophe. (Note: Even in the case of worldwide calamity, there are no assurances that U.S. Treasury bonds will be seen as safe at these levels.)

Since I do not believe that a 2012 collapse is inevitable, and because I protect all assets with stop-limit orders and/or hedges, I am far more inclined to pursue the risk-reward associated with emerging market bonds. To the extent European and China uncertainties exist, I favor dollar-denominated vehicles like PowerShares Emerging Market Sovereign (PCY) as well as iShares JP Morgan USD Emerging Market (EMB). If the Fed goes ”all-in” on reflating/currency debasing with a shock-and-awe level QE3, look for outperformance from local currency debt funds like Market Vectors Emerging Market Local Currency (EMLC).

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.