Emerging Markets Bond ETFs Continue Delivering

Emerging markets bond exchange-traded funds have been among this year's best-performing asset classes, a sentiment that rings true for dollar-denominated and local currency funds, such as the Market Vectors Emerging Mkts Local ETF EMLC.

The $2.4 billion EMLC, one of the largest local currency emerging markets bond ETFs, is up 15.2 percent year-to-date, delivering equity-like returns while throwing off a 30-day SEC yield of 5.35 percent. That is more than enough to make investors think twice about developed market bond funds.

Emerging Markets Debt

It is easy to understand investors' enthusiasm for emerging markets debt, dollar-denominated or local currency. German and Japanese 10-year sovereigns have negative yields. The comparable U.S. bond yields just under 1.8 percent.

Investors considering an ETF such as EMLC need to be mindful of developed world monetary policy, particularly the Federal Reserve's plans for U.S. interest rates.

Considering EMLC, Peers

“Interest rate volatility was a primary concern in September as the market grappled with the possibility that the major developed market central banks might be on the verge of policy shifts,” said VanEck in a recent note. “The European Central Bank and the Bank of Japan versions of quantitative easing are both under review and the anticipated impact of reversals or tapers led to steeper curves. In the U.S., the Fed remained on hold, as expected, but took a more hawkish tone with regard to the likelihood of a single hike before yearend. Even so, the scaled back rate expectations of Fed governors in the ‘dot plot’ showed only two potential hikes in 2017.”

Related Link: ETFs Not Getting Any Help From China

At the end of the third quarter, the Indonesian rupiah, Brazilian real and Polish zloty combined for over 30 percent of EMLC's currency exposure with those countries combining for over 27 percent of the ETF's geographic weight.

While EMLC can be riskier than traditional bond ETFs, it is not major credit risk as the fund devotes more than 56 percent of its weight to bonds with investment-grade ratings. That is more than double the ETF's exposure to junk bonds.

The Fed and other factors are likely to affect EMLC going into the end of the year.

“Near term uncertainty will likely come from the approaching U.S. elections, the continued positioning of Organization of Petroleum Exporting Countries (OPEC) members and the resulting impact on oil prices, and the precarious capital positions of some European banks,” added VanEck.

“Most significantly, the prospect of a December rate increase in the U.S. will increasingly come into focus. However with a liquidity backdrop that is still very supportive, yields that remain attractive, and fundamentals that continue to improve, we believe that the investment case for emerging markets debt is not likely to be diminished with the next rate hike.”

Full ratings data available on Benzinga Pro.

Do you have ideas for articles/interviews you'd like to see more of on Benzinga? Please email feedback@benzinga.com with your best article ideas. One person will be randomly selected to win a $20 Amazon gift card!