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Emerging Market Bond Etfs May Be Safer Than You Think

 May 24, 2012 12:48 PM


(By Ron) "May you live in interesting times." That's an old Chinese curse I think someone must have wished on us today.

We live in interesting but turbulent times. Europe is falling apart … global capital is bouncing around like a basketball … and the world's last superpower is spending itself into oblivion.

Where can you find refuge in this storm? Today I'll tell you about one possibility, and give you some ideas to consider.

Bonds Are Not Risk-Free

Bonds come in many flavors.

[Related -8 Stocks to Beat Warren Buffett's Portfolio Return Easily]

Investors whose goal is capital preservation have long tilted their portfolios toward bonds. Usually, this makes sense. Fixed-income securities tend to be more stable, while the interest payments put cash in your pocket.

On the other hand, bonds come in many flavors. Some are safer than others, and certain kinds of bonds can be highly speculative.

The bottom line is credit risk. When you buy bonds or bond funds, you are a lender. You hope the borrower pays you back on schedule. You might be wrong.

Emerging Market Bonds—
Safer in the Long Run?

If the borrower is located in a far-away emerging market, you face additional questions. What are the local laws? How do currency exchange rates affect your investment? Is the economy growing or shrinking?

[Related -How the Chinese Slowdown Will Impact Your Investments]

My response: Those same risks apply right here in the U.S. We've learned since 2008 that "rule of law" doesn't always apply. Our dollar is no longer as good as gold, and our economy is weak and getting weaker.

So I don't automatically assume bonds from emerging markets are riskier than domestic bonds. In some cases they may even be safer! Earlier this month I showed you how some of the world's fastest-growing countries have far outpaced the "developed" West.

Which capital is in better shape?

Let's turn the table around. Is it reasonable to believe that, ten years from now, a U.S.-based borrower will be in better shape than a similar borrower in China, Indonesia, or Chile? Keep in mind the borrower can be either a sovereign government or a private company.

Thinking about it this way gives you a different perspective. I'm not at all saying that the U.S. is doomed, or that China will own the world. My point is that the West no longer deserves "benefit of the doubt" when it comes to credit risk. Likewise, bonds from emerging markets nations aren't automatically more dangerous.

Diversity Is Key

Wherever you may invest in bonds, diversification is always a good idea. That's where bond ETFs really come in handy. With one trade, you can own a portfolio of many different bonds in whatever niche you find interesting.

(Editor's note: Ron's International ETF Trader helps members navigate ever-changing global market conditions by identifying which exchange-traded funds have the most profit potential at any given time. Click here to see his latest video.)

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Emerging Markets Government/Aggregate Bond ETFs

In theory, government-issued bonds are "safer" because they can raise taxes to pay their debts. Reality isn't always so simple. Governments also have the power to change their minds.

"Aggregate" bond ETFs contain a mixture of government and highly rated corporate bonds. Here are some to consider.

  • PowerShares Emerging Markets Sovereign Debt Portfolio (PCY)
  • iShares JPMorgan USD Emerging Markets Bond Fund (EMB)
  • WisdomTree Emerging Markets Local Debt Fund (ELD)

Note that PCY and EMB hold bonds denominated in U.S. dollars, which eliminates currency translation risk for U.S. investors. ELD and some others hold bonds issued in local currencies. This means you are exposed to those currencies along with the bond returns. Sometimes this works in your favor. But when the U.S. dollar is rising it can go against you, too.

Emerging Markets Corporate Bond ETFs

Like its cities' skyline, China's bond market is growing fast.

Businesses from top emerging markets have been slow to issue bonds. Why? Mainly because they haven't needed to borrow, and also because they don't always have the tax incentives that make U.S. companies lean toward debt financing.

This is changing over time. Now corporate bond markets are thriving in places like China. To get involved, check out …

  • WisdomTree Emerging Markets Corporate Bond (EMCB)
  • PowerShares Chinese Yuan Dim Sum Bond Portfolio (DSUM)
  • iShares Emerging Markets Corporate Bond (CEMB)

Emerging Market High Yield Bond ETFs

Bond yields are directly related to risk. Issuers perceived as potentially unstable have to entice borrowers with higher interest rates. In bond terminology "high yield" means "below investment-grade" or what used to be called "junk" bonds.

If you are comfortable with the risk, ETFs in this group can offer very high current income. Examples include …

  • iShares Emerging Markets High Yield Bond (EMHY)
  • Market Vectors Emerging Markets High Yield Bond (HYEM)

New ETFs come out all the time, so this isn't a complete menu. I hope you can see the potential benefits of emerging market bond ETFs.

Likewise, I want you to understand that U.S. and European bond ETFs aren't always safer. Wherever you may invest, be sure to shop carefully!

Best wishes,

Ron


This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

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