Emerging Alternative in Fixed Income

The iShares JPMorgan USD Emerging Markets Bond Fund (EMB) replicates the price and yield performance of the JPMorgan EMBI Global Core Index. The index is a U.S. dollar denominated emerging markets debt benchmark which tracks the total return of actively traded external debt instruments in emerging market countries. The top 5 country weightings are Brazil (9.95%), Russia (9.89%), Turkey (8.08%), Mexico (7.64%) and Philippines (7.08%). The fund was established December 17, 2007 and the MER is .60%. It has 62 holdings with a weighted average maturity of 11.56 years and an effective duration of 6.71 years. The weighted average coupon is 6.78%, the distribution yield is 5.44% and average yield to maturity of 5.68%. In terms of quality ratings, Moody’s rates the bonds held in the portfolio an average of Baa3. The majority of bonds fall into a range of B2/B to A1/A+ quality rating by Moody’s.

Over the last year EMB has grown from about $90 in share price to a high recently of $105.50 in addition to the distribution yield of 5.44%. The majority of price appreciation came prior to October 2009. In March the current price crossed the 50 and 100 day moving averages and has maintained its status since then. One thing that appears to be developing from a technical perspective is weakening momentum from both a relative strength perspective, which is currently falling and MACD, which is not signalling a buy.

Fundamentally I like emerging markets as an investment theme for fixed income, especially if we are limited in options as interest rates rise in mature economies. In the spring 2010 Global Investment Outlook the RBC Investment Strategy Committee they expect emerging markets to continue to deliver superior growth. This is supported by “relatively low debt levels of households and corporations, robust banking systems, undervalued currencies and high savings rates…Emerging markets are leading the global recovery, and we expect them to be the first to withdraw policy stimulus.” In addition, in Bloomberg.com “Brazil Trades A-Rated as Growth Makes Debt Safer” headline tells us that we can’t paint all countries the same when it comes to the sovereign debt crisis. The sovereign debt problems of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) has caused the spread to widen in government bonds between developed and less developed countries, arguably spilling over into emerging markets. This may have presented an opportunity for unjustified higher yields in emerging markets countries that don’t have these same problems.

Some of the risks include currency, challenges to the global economic recovery, credit downgrades and rising interest rates. From a currency perspective the index is in U.S. dollar denominated debt so the U.S. /CAD should cancel each other out and the fluctuation in currency should be between the currency of the originator bond and the Canadian dollar. Given the Canadian dollar forecast of strength against the U.S. as well as other currencies, this should bode well for holding this fund. Given duration of 6.71 years, a 1% rise in rates will cause a 6.71% drop in price of the bond pool on average. This still appears to be a great alternative in a rising interest rate environment as a component of your fixed income holdings in your portfolio.