New Emerging-Market Bond ETF Offers Twist

NEW YORK (TheStreet) -- One of the benefits of ETF proliferation is access to previously difficult-to-reach market segments for individual investors.

The latest example is the Market Vectors Emerging Market Bond ETF ( EMLC). There are already two emerging-market bond ETFs, but the iShares JP Morgan USD Emerging Markets Bond Fund ( EMB) and PowerShares Emerging Markets Sovereign Debt Portfolio ( PCY) hold bonds denominated in U.S. dollars. The new Market Vectors fund is the first ETF to hold bonds denominated in the currencies of the issuing countries.

Country weightings range from 3% to 10%. The countries with 10% are Brazil, Malaysia, Mexico, Poland, South Africa and Thailand. Indonesia and Turkey each have 8% weights, so 76% of the fund is in just eight countries. While the process is multifactor, it boils down mostly to giving the largest weightings to the countries with the largest debt outstanding -- which could be a drag on the fund in an investment world that has a greater awareness of sovereign debt levels. For example, Brazil has a 60% debt-to-gross domestic product level and Malaysia's debt-to-GDP is around 54%. While both are well below many of the developed markets believed to be most at risk of debt problems, a country such as Chile with only 7% debt-to-GDP is not in the fund at all.

The largest holdings show as being a Thailand bond maturing in 2018 at a 7% weight and a Malaysian bond at a 6% weight. One oddity in the holdings for now is that almost 20% of the fund is in AAA paper from such issuers as Rabobank and European Investment Bank, which appear to not be emerging-market bonds. Actually they are loans made in local currencies to countries represented in the index underlying the fund, and the holdings are temporary. The fund is brand-new; as it attracts assets, the plan is that new assets will go into sovereign issues and these AAA-rated bonds will be removed.

For some other stats on the index underlying the fund: The average modified duration is 4.42 years and the average coupon is 7.52% -- which, less the 0.49% expense ratio, implies a yield for the fund of 7%. But this remains to be seen. The fund is structured to pay dividends monthly, but that is contingent on the pay dates for the holdings within the fund.

A big argument for buying this fund will be the potential diversification benefit versus a U.S.-based investment portfolio, but like many things in investing it is not that simple. Per Van Eck's research and marketing literature for the fund, the index underlying Market Vectors Emerging Market Bond ETF has a 0.76 correlation to U.S. equities and a 0.54 correlation to U.S. bonds for the past three and half years.

Those numbers aren't static, though. Anyone investing in the space should expect the correlation to go up in the face of a 2008-style panic.

The diversification potential can pay off over time. The economic footing under most of the countries in the fund is better than the U.S., most of Western Europe and Japan. This creates long-term visibility for currency strength from these markets against the U.S. dollar, but during short-term panics the dollar is likely go up against these currencies in what would likely be referred to as "risk aversion."

The Market Vectors Emerging Market Bond ETF opens up an important asset class to do-it-yourself investors, but it will not be a one-way trade, even if the longer-term fundamental story is promising.

Readers Also Like:


Follow TheStreet.com on Twitter and become a fan on Facebook.

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; click here to send him e-mail.

More from Emerging Markets

U.S. Considers New Tariffs on Imported Vehicles

U.S. Considers New Tariffs on Imported Vehicles

Video: Here's How Global Stocks Can Boost Your Portfolio

Video: Here's How Global Stocks Can Boost Your Portfolio

Wall Street Looks To Extends Gains After Goldman Earnings Beat, China Data

Wall Street Looks To Extends Gains After Goldman Earnings Beat, China Data

China's President Xi Jinping Tells Boao Forum He Supports Opening Markets

China's President Xi Jinping Tells Boao Forum He Supports Opening Markets

U.S. Stock Futures Steady; Asia Stocks Mostly Lower

U.S. Stock Futures Steady; Asia Stocks Mostly Lower