Rising rate worries cast a spell of misfortune on bond ETFs investing lately. Speculation is rife that the dream run of the 30-year-old bullish bond market may finally be approaching its end.
At least, the latest pool of solid U.S. economic data and President-elect Donald Trump’s promises give such indications. Trump’s vows to cut taxes and boost fiscal spending raised inflationary expectations, pushing bond yields higher.
Also, the Fed chair Yellen enacted a rate hike in December and indicated to enact three more in 2017. The yield on benchmark U.S. Treasury note jumped to 2.38% on January 9 from 1.88% on the election day.
The Fed bumped up its projections for the benchmark interest rate for 2017, 2018 and 2019. Projections for 2017, 2018 and 2019 were ticked up from 1.1% to 1.4%, 1.9% to 2.1% and from 2.6% to 2.9%, respectively. These are meaningful jumps from the 2016 projected rate of 0.6%. Fed’s funds rate for the longer run was raised to 3% from 2.9% (read: Sole Fed Hike of 2016 Put These ETFs in Focus).
In such a situation, it is likely that U.S. investors will pull their invested money out of the high-yielding but risky emerging markets (EM). But we will highlight a few reasons why emerging market bond ETFs will prove to be good bets, going forward.
EMs Are Better-Positioned This Time than 2013
Though it is too early to take a call, the initial hints are in favor of EM investing. This is because EM economies are much more protected from Fed tightening shocks this time than they were in 2013, which is remembered for the taper-tantrum. In fact, unlike previous periods when several EM economies used to hike rates to contain the plunge in currencies, 2016 witnessed many EMs like Brazil, Russia, Indonesia and India lowering rates. Policy easing is likely to result in faster growth.
Yields Are U.S. Treasury-Beating
The Fed is on the policy tightening mode and U.S. Treasury bond yield is rising. Even then, yields are way below the EM ETFs. Plus, fixed-income securities are always less risky than equities. Even if EM bond ETFs end up facing capital losses, the regular stream of current income will guard investors’ portfolio (read: ETF Strategies for a Rising Rate Environment).
Credit Rating in EMs Better Than Before
As per the source, the clip of credit rating downgrades in EMs slowed in the second half of 2016.
Commodity Market in Better Shape
Emerging markets are commodity rich. While the commodity market suffered a lot previously, 2016 wrote a turnaround story. Oil prices are likely to pick up this year on the OPEC output cut deal and industrial metals are also expected to be in good shape globally given Trump’s pledge to invest about $1 trillion in U.S. infrastructure. As a result, stabilization of commodity prices should bode well for emerging market securities.
EMs Less Perturbed by Brexit
The year 2017 will likely see a ‘hard Brexit’, which may leave a less denting mark on the EM bloc. Going by an article in CNBC, EM investing will not be hurt that much save a huge upheaval in broader Europe, per BNP Paribas. And this impact will not be “in political terms but in trade terms.”
Also, an article published in barrons.com says that very few emerging markets share extensive trade relations with U.K. This is because the extent of trade agreement between advanced economies is way bigger than that between wealthy developed countries and still-striving emerging economies (read: Play These Emerging Market Bond ETFs to Lessen Brexit Woes).
ETFs in Focus
All these factors open up room for higher-yielding emerging market bond ETFs. However, since U.S. dollar is hovering at multi-year highs, a dollar-denominated EM bond would be better to rule out the currency translation risks. Investors should note that WisdomTree Emerging Currency Strategy ETF (CEW - Free Report) ) lost over 0.6% in the last one month (as of January 10, 2017).
ProShares Short Term USD Emerging Markets Bond (EMSH - Free Report) – Yield 5.90%
The fund is made up of a USD-denominated emerging markets bonds with less than five years remaining to maturity. It charges 50 bps.
iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB - Free Report) – Yield 4.75%
It gives exposure to U.S. dollar-denominated government bonds issued by emerging market countries. It charges 40 bps in fees (read: November ETF Asset Flow Report).
PowerShares Emerging Markets Sovereign Debt ETF (PCY - Free Report) – Yield 5.10%
The fund looks to track the potential returns of a theoretical portfolio of liquid emerging markets’ U.S. dollar-denominated government bonds issued by approximately 22 emerging-market countries. The fund charges 50 bps in fees.
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