As part of a diversified exchange-traded fund portfolio, advisors are including emerging-market assets to augment their foreign equities allocations. And now, considering the paltry yields in the U.S. Treasuries market, advisors may even look at the high yields offered by emerging-market debt securities.
After the recent quick turns in the equities market and greater uncertainty in the global markets, advisors have sought out income-generating assets to help cushion their portfolios. Consequently, the benchmark 10-year Treasury yields dipped below 1.4 percent earlier this year on safe-haven interest and the influx in demand for corporate bonds have depressed U.S. corporate yields.
Meanwhile, demand for emerging-market assets has risen, but yields in emerging-market debt remain attractive.
Emerging economies' balance sheets look much better than the developed world, especially as we try to borrow our way out of economic stagnation. For instance, the U.S. and Europe are sitting on debt-to-GDP ratios of about 100%. In contrast, the emerging countries' debt-to-GDP ratios fall under 40%. While emerging-market debt is rated as speculative, non-investment grade, some have even argued that they may actually be better credit risks due to their low debt-to-GDP levels.
The emerging markets offer robust returns, but advisors will require a higher credit-risk tolerance. Many have included allocations into emerging-market assets as they hope the rapid GDP growth rates would translate to better returns. But since these emerging economies are still in their developmental stages, the markets may experience more extreme bouts of volatility and economic risks. Moreover, emerging economies come with greater political risks, as well.
Advisors will also need to keep tabs on the yields offered and on inflation expectations. Emerging-market debt will be subject to real interest-rate risks. If the inflation outlook drops, advisors can expect a positive impact. On the other hand, if real interest rates increase, the securities will be pressured.
High-Yield Emerging Market Bond ETFs
ETF advisors interested in the high-yield segment of the emerging market bonds category may consider these two options: the iShares Emerging Markets High Yield Bond Fund (EMHY) and the Market Vectors Emerging Markets High Yield Bond ETF (HYEM).
The $20.9 million iShares EMHY ETF has a 0.65 percent expense ratio and includes 120 holdings, with credit ratings of AA+ 0.5%, AA 0.9%, BBB- 3.5%, BB+ 12.2%, BB 21.0%, BB- 5.4%, B+ 22.6%, B 8.5% and B- 4.6%.
EMHY has an average maturity of 9.4 years and an effective duration 5.9 years -- a 1 percent rise in rates would diminish the ETF's price by 5.9 percent. The fund comes with a 5.93 percent 30-day SEC yield.
Country allocations include Turkey 14.2 percent, Venezuela 12.5 percent, Philippines 11.0 percent, U.S. 7.0 percent, Ukraine 4.4 percent, Lebanon 4.3 percent, Hungary 3.9 percent, Russia 3.1 percent, Argentina 2.8 percent and Brazil 2.6 percent. Sector allocations include public debt 63.0 percent, industrial 27.4 percent, financial 3.4 percent, utility 1.9 percent, all agency 1.0 percent and S-T Securities 0.9 percent.
The $15.3 million Market Vectors HYEM ETF has a 0.40 percent expense ratio and includes 95 holdings, with credit ratings of BB 47.9 percent, B 38.8 percent and CCC 3.1 percent.
HYEM has an average maturity of 6.5 years and an effective duration of 4.06 years. The ETF has a 7.41 percent 30-day SEC yield.
Country allocations include Cayman Islands 13.1 percent, Netherlands 8.2 percent, Venezuela 8.1 percent, Luxembourg 6.4 percent, Ireland 5.7 percent, Bermuda 4.5 percent, Mexico 4.3 percent, Turkey 3.7 percent, U.K. 3.7 percent and Virgin Islands 3.6 percent. Sector allocations include basic industry 21.9 percent, energy 12.7 percent, real estate 11.7 percent, telecom 7.7 percent, services 4.0 percent, consumer non-cyclical 3.7 percent, capital goods 1.0 percent, technology 0.7 percent, automotive 0.3v, banking 15.6 percent, financial services 0.4 percent, utility 11.2 percent, government guaranteed 4.9 percent and local authority 2.8 percent.
Both funds hold U.S. dollar-denominated assets, so advisors do not need to worry about currency risks. However, the iShares EMHY fund has a greater emphasis on emerging market sovereign debt which may explain its slightly lower yield. On the other hand, the Market Vectors HYEM largely holds emerging market corporate bonds.
Additionally, potential advisors should be aware that both these funds are relatively new and may trade on low volumes. Consequently, some may experience liquidity issues on the low volumes. Advisors should make sure to check the bid/ask spreads before initiating trades and try to utilize limit orders to keep full control over trades.