Emerging Market Bond ETFs About To Crash?

by: Shaun Connell

Emerging markets had 2-5 billion in assets invested over the last decade or so -- that is, until banks and investors began picking up the pieces from the 2008 bust.

Then, investors looking for decent yields began dumping their assets into bond ETFs that offered great returns, and the emerging markets were seen as the only places still growing well.

Unfortunately, not all economic growth goes without a hitch, and a sudden flow of credit isn't always a great thing.

As we can see here, emerging market bonds were relatively stable market size, and then began to shoot up to about 2010.

Still, as of the last few weeks investors have been pulling their money out of EM bond funds this last week according to the Financial Times. As they report:

Local currency bonds were the first to lose favour as EM currencies, led by the Brazilian real, went into reverse. But for the past fortnight even EM dollar-denominated bonds have fallen out of favour.

As Barclays noted: '[This] week, a greater percentage of outflows were attributed to local currency funds, as EM currencies have suffered in the recent risk-off period, while last week the outflows were relatively divided between local and hard currency funds.'

Whether emerging market bonds are a great place to find yields really depends on the economic slowdown facing the world. Brazil's equity markets have taken a beating, and China's entire economy has been grinding to a halt.

If emerging markets continue to slow, risk might be increasing and bond funds like EMB, PCY, and the local currency bond funds like ELD, EMLC, LEMB and others could be hit as well.

Personally, US corporate bonds are providing returns good enough that looking to emerging markets simply isn't necessary, though the occasional higher yield can make it worth the allocation.

This doesn't mean in the short run bond funds like VCLT are necessarily going to do well -- they've shot up dramatically in the last several months, and are probably due for a typical correction very soon. I have my short-term money in cash right now rather than even taking risks with bonds.

I'm playing it safe, though we should know within the next 30 days whether the EM and US bond scene is soon to correct and, if so, how much.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.