Q: What's really happening in emerging markets?
A: Two bad apples are spoiling the barrel.
The sovereign bonds of Argentina and Venezuela lost 11.8 percent and 8.7 percent, respectively, during the month of January. The team at Ned Davis Research notes that in spite of accounting for only 5 percent of the Barclays Emerging Markets Dollar Denominated Bond Index, these declines caused the entire index to post a 28 basis point loss for the month. In other words, the rest of the world's emerging sovereign debt was actually up.
The observation surprised us, especially since there have been so many other hot spots within emerging markets recently:
- Protests in the Ukraine over a trade deal with Russia
- A virtual coup d'etat in Thailand and a call for free elections
- Tensions in Turkey over an overnight doubling of rates
- New lending curbs in China
- Car bombs in Iraq
- Iran being omitted from Syrian negotiations
The relative calm for sovereign bonds ex-Latin America is even more surprising when measured against stocks, which have declined across the board. Consider the iShares MSCI Emerging Markets ETF (EEM), comprised of 16 percent in South Korea, 15 percent in China, 12 percent in Taiwan, 10 percent in Brazil, 7 percent in South Africa, etc. Argentina and Venezuela aren't even in the top 10.
The discrepancy led us to an often-overlooked ETF, the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY). It typically trades about 500,000 shares per day, so it's liquid but not exactly "on the radar." Most notably, it's up on the year. In addition, it pays a dividend of 4.7 percent, contains no Argentina bonds and Venezuela accounts for only 3.6 percent of holdings.
For investors intent on emerging market exposure, PCY is the one vehicle that has survived January unscathed.