Reconsidering Emerging Markets Bonds

Benzinga

Investors are well aware that 2015 has been a brutal year for emerging markets equities and currencies. With the dollar strengthening and the Federal Reserve poised to raise interest rates later this year, exchange-traded funds holding developing world debt denominated in local currencies have also been punished in 2015.

Add to that, there has not been much reason to embrace emerging markets corporate bond ETFs. Actually, a case can be made that with defaults on the rise, such ETFs should be avoided. Citing Standard & Poor's, the Wall Street Journal reported that emerging markets corporate bond defaults are up 40 percent from last year and reside at the highest levels since 2009.

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What Are Some Options?

So, give the WisdomTree Emerging Markets Corporate Bond Fund (WisdomTree Trust (NASDAQ:EMCB)) some credit for being down just 6.5 percent year-to-date. Obviously, that performance is nothing to crow about, but the largest U.S.-focused investment-grade corporate bond ETF has also traded lower this year.

Looking At EMCB

Credit risk is not substantial with EMCB, as bonds rated AA, A or BBB combine for nearly 52 percent of the ETF's weight. And the good news is the nearly 80 bonds held by EMCB are dollar-denominated, meaning the ETF is less vulnerable to changes in Federal Reserve policy.

Note, unlike many of the sovereign countries that issue their debt in U.S. dollars and earn revenue solely in their local currencies leading to a different and often hidden currency risk due to the debt being owed to lenders in U.S. dollarsmany emerging market corporations, especially commodity-centric ones, also earn their revenue in U.S. dollars. These emerging market corporations therefore have a better asset and liability matching than the countries issuing debt in U.S. dollars, said WisdomTree in a recent research note.

Risks to EMCB's lineup include the potential for more corporate debt downgrades in Brazil and the potential for the same in Russia's energy sector. Brazil and Russia combine for just over 23 percent of EMCB's weight. On the other hand, EMCB features no exposure to South African or Turkish corporates, which is notable because those countries are believed to be at a risk of sovereign downgrades, an event that could stoke concern about the health of private sector debt issuers.

While neutralizing the currency headwind to returns did improve the picture, it was still not quite enough for a positive return. However, this shows just how important it is to think carefully about different emerging market options. We think that pairing an investment vehicle like EMCB with other emerging market investments that may have currency exposure could offer an interesting strategy, adds WisdomTree.

EMCB, which allocates nearly 27 percent of its combined weight to Chinese and Hong Kong corporates, has a 30-day SEC yield of 5.16 percent and an effective duration of 5.19 years.

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