Market Overview

Considering PowerShares' Emerging Markets ETF

Considering PowerShares' Emerging Markets ETF
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As sovereign debt yields in developed markets plummeted and, in some cases, turned negative, income investors turned to emerging market debt for higher yields. Plenty of emerging markets bond exchange traded funds are listed in the U.S., but the iShares J.P. Morgan USD Emerging Markets Bond ETF (NASDAQ: EMB) is the largest, with nearly $12 billion in assets under management.

EMB is the largest emerging markets bond fund of any stripe in the world, but there are other options to consider. For example, the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSE: PCY) is a viable competitor. PCY is the second-largest ETF holding developing world debt behind EMB.

PCY turns 11 later this year and has over $5 billion in assets under management. Both EMB and PCY hold dollar-denominated bonds.

An Alternative

EMB is a cap-weighted fund, meaning the largest issuers and individual issues command the biggest percentages of the fund's weight. PCY uses a different approach.

“To address this issue, PCY’s DB Emerging Market USD Liquid Balanced Index benchmark equally weights its holdings by country and by issue,” Morningstar said in a recent note.

PCY holds 93 bonds and its largest country allocation commands just over 4 percent of the fund's weight. Just over three-quarters of the fund's holdings are rated BBB, BB or B.

“The fund targets bonds with the largest yields and equally weights each country and issuers within each country based on a defined set of criteria established by the Deutsche Bank emerging-markets index committee,” according to Morningstar.

Geographic Risk

About a quarter of PCY's roster carries a non-investment grade rating, a trait reflective of PCY's different country allocations relative to competing funds. While many emerging markets bond funds are heavy on the likes of Brazil, Mexico and Russia, PCY also holds debt from smaller developing markets, such as El Salvador, the Dominican Republic and Kazakhstan.

“For example, the fund held debts from Slovenia, Qatar and Latvia in 2017. These countries’ obligations are less frequently traded than debts from other large emerging markets such as Indonesia and Mexico, making them costlier to transact,” according to Morningstar.

PCY offers some compensation for the credit and geographic risk in the form of a 30-day SEC yield of 4.46 percent. Past performance is never a guarantee of future returns, but PCY and EMB have performed inline with each other over the past three years, each generating returns of about 15.5 percent.

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