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Are Dollar Denominated Bond ETFs Better Bets in EM Space?

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With the U.S. economy shining better than many developed economies currently and the Fed looking hawkish, the greenback has regained its lost strength. PowerShares DB US Dollar Bullish ETF (UUP - Free Report) has gained about 4.1% in the past one month (as of May 9, 2018).

The dollar’s strength has marred the repatriated value of overseas gains and resulted in a turmoil in the emerging market (EM) currency space.  iShares MSCI Emerging Markets ETF (EEM - Free Report) haslost 3.2% in the past one month.Still, many are being optimistic about emerging markets, as many of these fast-growing nations remain on a solid growth track (read: Is Taper Tantrum Back in 2018? EM ETFs in Focus).

Why Taper Tantrum Not Likely?

The EM had suffered an extremely rough stretch five years back on news of the Fed’s QE taper and the resultant rise in the interest rates and the greenback. Though the recent EM selloffs resemble the taper tantrum, investors from AllianceBernstein LP to Morgan Stanley and UBS Wealth Management believe that the selloff will not be close to what we saw in May 2013.

This is because the EM space is much more insulated this time around. Several economies including Brazil, India and South Africa have lowered their current-accounts’ deficits in the past five years and Thailand has changed its deficit to a surplus of more than 10% of GDP, per Bloomberg. This has helped these countries to rely less on foreign investments.

Dollar-Denominated Bond ETFs in Focus

Still concerns remain. WisdomTree Emerging Currency Strategy ETF (CEW - Free Report) has been off about 3% in the past one month. So, investors still wanting an EM exposure amid a strong dollar, can consider dollar-denominated EM bond ETFs. These funds invest in sovereign debt from a variety of emerging nations but do so via U.S. dollar-denominated securities.

Notably, the debt route is less risky than equities. Moreover, most emerging markets have low debt loads than developed countries. On average, across Emerging Market and Developing Economies (EMDE), government debt rose by 12 percentage points of GDP since 2007 to 47% of GDP by 2016.

On the other hand, European Union (81.60%) and developed economies like Japan (253%), United States (105.4%) and United Kingdom (85.3%) have a much higher government debt to GDP (as of December 2017) (read: EM ETFs: What You Need to Know Before Investing).

Yields in the EM bonds are much higher when compared to similar bonds for developed markets. Investors should note that iShares JP Morgan USD Emerging Markets Bond ETF (EMB - Free Report) has added about $42.67 million in assets this month (as of May 10, 2018). In contrast, iShares MSCI Emerging Markets ETF (EEM - Free Report) has shed about $1.01 billion in assets and VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC - Free Report) has lost about $29.43 million in assets, per etf.com.

Given these positives, it could be time to look at emerging market dollar-denominated bond ETFs for exposure.

iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB - Free Report)

The fund is heavy on Mexico (6.08%), Indonesia (4.93%) and Turkey (4.27%). Its effective duration is 7.23 years while weighted average maturity is 11.96 years. It charges 40 bps in fees and yields 4.60% annually.

PowerShares Emerging Markets Sovereign Debt Portfolio (PCY - Free Report)

The 111-security basket has an effective duration of 9.23 years and years-to-maturity is 17.55. It charges 50 bps in fees and yields 4.93% annually.

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