NEW YORK (TheStreet) -- Sovereign debt has earned a bad name this year, with Greece's budget crisis spreading to other parts of Europe. Those concerns have helped drag down the U.S. stock market.
But there are emerging-market countries whose debt and budget situations are on much firmer footing. For interested investors, there are two exchange traded funds that buy emerging-market sovereign debt.
PowerShares Emerging Markets Sovereign Debt Portfolio
has been for sale for two and half years and has attracted $590 million in assets. Its holdings' effective duration is just under eight years. Forty-five percent of the ETF is rated BBB and 27% rated BB, and it yields about 6%. There is little single-country risk, with Indonesia and the Philippines being the largest positions, at 5%. Countries in the fund that usually don't get a lot of attention include Uruguay and Bulgaria.
iShares JP Morgan USD Emerging Markets Bond Fund
has been trading almost as long as the PowerShares ETF but is much larger, at $1.4 billion in assets. Its effective duration is seven years. Twenty-two percent of the fund is rated BBB-plus, 12% is BBB-minus and 11% is BB-minus. It yields 5%. The iShares fund makes larger country bets, with 9% each to Russia and Brazil, and 8% each to Turkey and Mexico.
At their lows, both emerging-market bond ETFs were down 40%, but that was around the time of the Lehman Bros. collapse. Both have since returned to their respective highs from before the bear market for equities started.
While the fundamentals may not have improved since Lehman's lost weekend, the odds of a bond-market malfunction are low. This creates a backdrop in which emerging-market countries' currencies can outperform the dollar. This is especially true after the rally that the dollar has enjoyed of late. However, it's crucial to understand that the bonds in both funds are denominated in dollars, so currency appreciation doesn't directly impact the price of the bonds but it would make the interest payments less costly when converted into the U.S. currency and paid out to bondholders, which is a net positive.
Herein lies the funds' risk. Currency devaluation becomes problematic for a country with a lot of foreign debt outstanding. (Think about Iceland's residents with mortgages in euros when the Icelandic kroner fell by half.)
Between the two funds, I prefer PowerShares for its smaller country weightings. In terms of past performance, the differences in country selection haven't mattered, so this is more about avoiding future problems.
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At the time of publication, Roger Nusbaum had no positions in the securities mentioned.
Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
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