Concerns About a Crowded Emerging Market Trade

As emerging markets are rebounding and sovereign bond yields throughout the developed world remain low and, in some cases, negative, investors have been flocking to exchange traded funds such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY).

EMB has a 7.18 year duration and a 4.45% 30-day SEC yield. PCY has a 8.97 year duration and a 4.75% 30-day SEC yield. The VanEck Vectors Emerging Markets Aggregate Bond ETF (NYSEArca: EMAG) has a 4.65 year duration and a 3.94% 30-day SEC yield.

SEE MORE: It’s Easy to Explain Investors’ Affinity for EM Bond ETFs

However, some market observers are concerned the emerging markets bond trade is becoming a crowded trade. While yields in developed economies remain depressed, with some even trading with negative yields, emerging market bonds have quickly gained traction as one of the few areas left with attractive yields. The JPMorgan global diversified composite index that covers emerging market bonds has increased almost 15% year-to-date.

“Debt funds in EM saw net inflows of $2.4 billion in the latest weekly reporting period, according to Bank of America Merrill Lynch data. Emerging market equity fund net inflows have tapered off, at $1 billion in the latest week,” reports Dimitra DeFotis for Barron’s.

Emerging currencies have strengthened on improving commodity prices, notably the rebound in crude oil prices, as many developing economies are major exporters of raw materials.

Consequently, more investors are looking to emerging market yields, despite the risks associated with the developing economies.

Emerging market bonds are being supported by the ongoing low-yield environment. According to the S&P Investment Policy Committee, the latest growth and inflation forecasts out of the Federal Reserve was not any different from figures reported back in June, which suggested that interest rates may remain lower for longer, with the yield on 10-year Treasuries still hovering around a depressed 1.6%.

SEE MORE: Emerging Market Bond ETFs Gain Momentum in Low-Yield Environment

“’Crowded’ trades are emerging market debt (largest 13-week inflows ever of $27 billion), investment-grade debt (inflows in 29 of past 30 weeks), municipal bonds (54 straight weeks of inflows); “vacant” trades: European equities (record 34 straight weeks of outflows), active equity mutual funds (30 straight weeks of outflows),” according to BofA Merrill Lynch in a note posted by Barron’s.

For more information on the fixed-income market, visit our bond ETFs category.

Tom Lydon’s clients own shares of EMB.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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