Trading The Globe: Caution On Emerging Debt? (EMLC, EBND, PCY, EMB)

Tim Seymour:  Emerging debt markets have become one of the most crowded trades on the planet, for better or worse. This week on CNBC’s Trading the Globe, we drill into whether these bonds still make sense.

The high interest rates that foreign bonds carry — Brazilian rates are still above 12% — have made them a favorite asset for global macro funds looking to borrow at near-zero rates in the developed world and lend at a tidy profit in emerging markets.

Early this month, the global flight from risk sucked all the liquidity out of these markets. Those high interest-rate margins are blowing out even further as traders try to cash out — but find few buyers even at marked-down prices.

Is this asset class worth a fresh bid?

On the one hand, you have emerging sovereign debt, which is more insulated from risk but pays much lower rewards compared with the level of risk.

Part of the problem is that while these governments aren’t looking to kick out established foreign investors, they are driving away fresh funds. In other words, if you aren’t in the asset class, it is getting harder and harder to buy your way in.

For example, Brazil is taxing new purchases of its bonds, while Turkey is also investigating ways to keep foreigners from buying into its credit markets.

Key vehicles for this side of the emerging debt market are ETFs such as PowerShares’ Emerging Markets Sovereign Debt (NYSE:PCY), the Market Vectors Emerging Markets Local Currency Bond fund (NYSE:EMLC) or the Emerging Markets Local Bond fund (NYSE:EBND) from iShares, which are 100%, 100% and 88% invested in government securities, respectively.

On the corporate side, emerging debt is much more of a mixed bag. Sadly, there is no ETF that concentrates on emerging corporate bonds — the closest you will get is JPMorgan’s Emerging Markets Bond (NYSE:EMB), which is roughly 14% weighted to these securities.

Still, you can get good yields on relatively high-quality securities, provided you can stomach the volatility while you hold them to maturity.

These bonds make an excellent diversification tool and once-record issuance of new debt has died off, so supply should shrink in the future, soon.

Pick higher-grade companies, and in countries such as Brazil you can still earn more than 10%. Look for maturities in the 3- to 4-year range.

As far as negatives go, the dollar can be a real killer. Remember, you are investing in local rates, so be careful.

At this point, inflation is a structural factor for emerging markets, given high employment and persistent supply bottlenecks, so you will have to accept a bit of erosion

And one last caution: you have as good an idea as I do where oil prices are going, but if crude falls out of bed, spreads in emerging markets will really push out, 2008-style.

Written By Tim Seymour From Emerging Money

Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market investments. CNBC Emerging Markets Contributor Tim Seymour leads the team of Emerging Money to bring you cutting edge global news and analysis.

About Tim Seymour: Tim is a founder of Emerging Money. He is a founder and Managing Partner at Seygem Asset Management, and The Emerging Markets Contributor to CNBC. Seygem Asset Management focuses on investing throughout the global emerging markets asset class. With a view that emerging and developing economies will continue to outpace the economic growth and advancement of developed economies, Seymour has devoted a career to investing in the dominant markets of tomorrow, today. Seymour’s career has included significant experience in both alternative asset management (hedge funds) and capital markets, having launched two hedge funds, and built the largest Russian broker dealer in the USA. Seymour started his career at UBS, focusing on international credit (cash, swaps, forex) in a specialized hedge fund group (New York). Seymour completed the firm’s training program after graduating with an MBA in international finance from Fordham University. Seymour received his undergraduate degree at Georgetown University.

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