There's Still A Case For Emerging Market Bond ETFs

Price action confirms that, as expected, emerging markets assets did not enjoy the outcome of last month's U.S. presidential election. The ensuing rally in the U.S. dollar ensured previously hot emerging markets bonds suffered last month as well.

Emerging Markets And The U.S. Presidential Election

The Market Vectors Emerging Mkts Local ETF (NYSE:EMLC), which as its name implies, holds emerging markets debt denominated in local currencies, fell 7.7 percent last month.

Emerging markets governments and some corporations binge borrowed in dollars during the various versions of the Fed's quantitative easing programs. It looked smart, as the dollar weakened against a plethora of developed and emerging currencies, but those emerging markets borrowers were caught off guard when the dollar started soaring several years ago.

With dollar soaring in the wake of President-elect Donald Trump's victory and in anticipation of the Federal Reserve boosting interest rates later this month, emerging markets bonds and ETFs such as EMLC make for easy targets for the vulnerable label, but there might be more to the story. Notably, today's emerging markets debt market looks much different than it did a decade ago.

The emerging markets debt asset class has grown tremendously in the past two decades. It now has a market capitalization of more than $3.6 trillion (as of October 31, 2016), as measured by J.P. Morgans emerging markets bond indices, versus approximately $1.1 trillion ten years ago. In addition to its growing size, the emerging markets debt market has become incredibly diverse and now includes bonds issued by sovereign, quasi-sovereign, and corporate entities in both hard currencies (mainly U.S. dollars and euros) and local currencies, said VanEck in a recent note

The Case For EMLC

EMLC has a 30-day SEC of 5.94 percent, which is eye-popping in a world of low and negative sovereign debt yields throughout the developed world. One of the reasons the ETF has struggled in recent weeks is its Mexico exposure.

Latin America's second-largest economy is EMLC's second-largest country weight, which has been a drag on the ETF in the wake of Trump's win because of his harsh rhetoric aimed at Mexico. Not to mention the peso has been a laggard among emerging currencies this year. On the upside, Mexico carries an investment-grade rating and is historically not as volatile as other emerging economies.

Growth in the market size has been driven primarily by the increased issuance of local currency-denominated sovereign bonds, as well as corporate bonds. The emerging markets corporate debt market alone nearly equals the size of the U.S. high yield bond market. Many foreign investors gravitate towards hard currency sovereign and corporate bonds, typically those denominated in U.S. dollars, to limit currency risk. However, the local currency market far exceeds the hard currency market in size, added VanEck.