Time for Emerging Markets Corporate Bond ETFs?

Ultra-low interest rate environment in the U.S. is forcing the yield-starved investors to look for alternative sources of income. One attractive investment option for the investors is the emerging market debt, which offers much higher yield and lower interest rate risk, along with capital appreciation potential.

Currently the emerging markets represent about one-third of global GDP and their share will continue to grow in the coming years. The expected growth rate for the emerging economies is 5.6% compared with 1.5% for developed economies, for 2013 per IMF.

Emerging markets’ fundamentals continue to be positive. Many emerging nations have better fiscal health than the developed countries. Further they have low correlations with the developed markets and thus they add diversification benefits to the portfolio. (Read: 3 ETFs To Prepare For The Fiscal Cliff)

Additionally, while interest rates are already at rock-bottom levels in the U.S. and can only go up from the current levels, the rates in emerging countries are still high. The central banks in many of these countries were raising rates till last year but reversed the monetary cycle later last year or earlier this year, as the growth slowed and inflation came within their acceptable range.

With inflation reigned in, these central banks now have more flexibility to cut rates further, in order to support growth. Thus the investors investing in the emerging markets debt have better chances of capital appreciation.

As a result of increased interest in this asset class, many new ETFs targeting this space have been launched recently. The investors can choose between the debt issued by the governments or the corporates. (Read: Obama or Romney? Win with These ETFs)

In recent years, as the sovereigns are increasing to issue debt in local currencies, the investors seeking more options in US dollar denominated emerging markets debt are looking at debt issued by the corporates. The ETF options currently available in this space invest only in US dollar denominated debt as the local currency corporate debt markets in these countries are still illiquid.

Most of the companies that these ETFs invest in have lower debt levels as well as lower default rates than many companies in the developed markets. Further, better demographics in these countries will ensure longer-term growth potential for these companies. (Read: Three Excellent Dividend ETFs for Safety and Income)

WisdomTree Emerging Markets Corporate Bond Fund (EMCB - ETF report)

EMCB—the first ETF in this asset class invests in US dollar denominated debt issued by public, private or state-owned/corporations in the emerging market nations in Asia, Latin America, Eastern Europe, Middle East and Africa.

The ETF has been able to attract more than $60 million in assets within a few months of its launch. The fund employs a “top-down” analysis of macroeconomic factors and “bottom-up” analysis of countries and issuers.

The fund has highest exposure to Oil & Gas sector (35.3%), followed by Industrials (20.2%) and Metals & Mining (19.5%). In terms of country exposure Brazil (25.7%), Russia (18.0%) and Mexico (12.1%) occupy the top three spots. About 75% of the fund’s holdings are investment-grade rated.

iShares Emerging Markets Corporate BondFund (CEMB - ETF report)

CEMB tracks the Morningstar Emerging Markets Corporate Bond Index that represents the performance of US dollar denominated debt issued by companies in emerging markets.

Brazil (16.9%), South Korea (10.4%) and Mexico (7.8%) are the top three countries that the fund has invested in. More than half are securities are from Industrials (55.8%) sector, while Financials (26.5%) and Utility (10.1%) round out the top three.

More than 70% of the debt held by the fund is investment grade rated.

SPDR BofA ML Emerging Markets Corporate Bond ETF (EMCD - ETF report)

EMCD is the latest entrant in the broader emerging market corporate bond space. It holds senior and secured US dollar debt issued by the corporate in the emerging markets.

With 460 holdings, it is most diversified of the three. Brazil (19.9%), Russia (14.5%) and Mexico (11.2%) are the top three in terms of country exposure.

Like CEMB, this ETF also has highest exposure to the Industrials (39.0%), followed by Non-corporates (35.3%) and Finance (12.5%)

About 80% of the securities held by the ETF are investment grade rated.

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