Here's What Bonds Yielding Over 37% Do To An ETF

Seasoned emerging markets investors (and sadists for that matter) might get a kick out of wondering what a dedicated, equity-based Venezuela exchange traded might look like as the South American nation is ravaged by hyperinflation and a tumbling bolivar.

Fixed income investors do not have to wonder how Venezuela's jaw-dropping sovereign debt yields affect bond ETFs because some bond funds trading in the United States have exposure to the country's sagging debt. On Wednesday, Venezuelan one-year notes closed with a yield of over 66.5 percent, according to Investing.com data.

The $223.7 million iShares Emerging Markets High Yield Bond ETF (BATS: EMHY) has a 5.8 percent weight to Venezuelan bonds, making the country the ETF's fifth-largest geographic weight. EMHY allocates a combined 68.5 percent of its weight to bonds with maturities ranging from five to 15 years. In Venezuela, such bonds yield over 37 percent and 27 percent, respectively.

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Recent research from Bank of America Merrill Lynch shows credit default swaps (CDS), the instruments used by traders to protect against and profit from issuer default, on Venezuelan debt approaching 5,000 basis points. That is more than double comparable CDS for Greek and Ukraine bonds.

Venezuela, Latin America's largest oil producer and a member of the Organization of Petroleum Exporting Countries, is part of the reason why EMHY has a 30-day SEC yield of almost 7.7 percent.

To be fair to Venezuela, the country is not EMHY's only problem child. Actually, Venezuela is not even EMHY's Latin American problem child. Brazil, a country flirting with losing its investment-grade credit rating, on the brink of bankruptcy Argentina and Mexico combine for almost 18 percent of the ETF's weight. Six of the 10 country's with highest CDS rates according to Bank of America Merrill Lynch are found on EMHY's roster.

The 344 bonds held by EMHY are denominated in U.S. dollars, which is problematic at a time when emerging markets currencies, including Russia's ruble, Brazil's real, Turkey's lira and Indonesia's rupiah, are plunging against the dollar. Those are EMHY's four largest country weights, combining for over 51 percent of the ETF's weight.

Then there EMHY's to countries that have recently devalued their currencies, including China and Kazakhstan. Those two countries combine for 6.25 percent of EMHY.

But even with all those headwinds, EMHY is down just 3.4 percent year-to-date, a performance that is only modestly worse than that turned in by the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSE:EMB). EMHY has also sharply outperformed the MSCI Emerging Markets Index while offering a yield nearly triple that of the equity benchmark.