by Daniel Putnam | June 14, 2013 6:30 am
Just a few months ago, emerging markets were riding a wave of positive momentum amid investors’ continued search for yield. In the 10 years through March 31, the JP Morgan EMI Global Diversified Index had produced an average annual return of 10.2%, beating all segments of the bond market, as well as the 8.5% annual return of the S&P 500 Index.
Unfortunately, this stellar performance masked the fact that emerging-market bonds remain sensitive to global risk factors.
Given that downturns have been rare in recent years, this aspect of emerging debt might have been lost on new investors who are new to this area. According to IndexUniverse.com, the iShares JPMorgan USD Emerging Markets Bond Fund (EMB) — which attracted $1.1 billion in new assets during the 12 months ended April 30 — has shed more than $536 million since the beginning of May.
Performance helps explain this exodus. EMB has been hit for a loss of 8.3% since its most recent peak on May 2, its worst stretch since early 2009. Local-currency funds such as Wisdom Tree Emerging Markets Local Debt Fund (ELD), down 9%, have underperformed slightly amid the evacuation from higher-risk currencies, while funds invested in less-liquid corporate and high-yield bonds have held up somewhat better.
This selloff — which makes emerging market debt the worst-performing segment of the bond market, with the exception of long-term Treasuries — highlights two key developments:
In this sense, global macro factors continue to exert as much, if not more, influence on emerging-market bonds as region-specific developments.
The other factor weighing on emerging-market debt is that low yields have made the asset class more sensitive to U.S. interest-rate movements than it was in the past, when yield spreads were much higher. Once Treasury yields spike — as they have since the beginning of May — there is much less of a spread “cushion” to absorb the move.
The positive side of this selloff is that emerging-market funds are beginning to offer investors some yield again. EMB, which invests largely in government debt, now has an SEC yield of 4.2%, up from the 3.5% range in early May. PowerShares Emerging Markets Sovereign Debt Portfolio ETF (PCY), for its part, now yields 4.3%, up from the 3.7% neighborhood just one month ago. iShares Emerging Markets High Yield Bond ETF (EMHY), tops in the group, now checks in with a yield of 5.8%. What’s more, emerging debt offers investors the chance to own an asset class coming off of its worst slump in over four years.
But while emerging-market bonds are looking more compelling here than they were in early May, investors still need to approach this area with great care. If the past few weeks are any indication, emerging-market debt is just as vulnerable to global crosswinds today as it was a decade ago.
History might not repeat itself, but in this case, it has certainly rhymed.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.
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