Turkey and emerging market debt

by , 16th September 2018

The Turkish Central Bank raised interest rates last week in a bid to prop up the declining Lira and stop investors fleeing Turkish markets. The Lira has depreciated just over 40% against the US dollar this year and the country’s troubles are now sparking panic in emerging markets.

In the past month there has been a sell-off in Turkey, Indonesia and Argentina – all of which have also hiked their rates.

It’s a blow to emerging market debt, which has seen stellar returns over the last couple of years. It’s done better than comparable developed market government bonds, which have suffered low rates or in some cases negative yields. See graph below: The iShares J.P. Morgan USD EM Bond UCITS ETF (SEMB) is in black and the iShares Core UK Gilts UCITS ETF (IGLT) is in orange (both are in sterling).

Source: Bloomberg

A combination of a strengthening dollar, the Turkish crisis and Trump’s trade wars have seen investors start to pull out of emerging market debt this year.  According to Morningstar, €1 billion was pulled from Europe-domiciled ETFs in the Global Emerging Market Bond Local Currency category in March, April and May of this year.

However, this may not spell the end of the EM debt story and there are a number of reasons is could still be attractive.

One way investors might be able to get around the issue of a strengthening dollar is to buy EM debt in dollars. LEMB, which is the iShares JP Morgan EM Local Currency Bond ETF on NYSE Arca dropped  -7.47% in the past three months compared to the iShares JP Morgan USD Emerging Markets ETF (EMB), which only fell -0.16% in the same time.

One of the issues that crops up when dollar strengthens and emerging markets sell off is that there is a broad decline in prices across emerging markets, but there are still countries and companies that have strong fundamentals and are unfairly punished as a result.

In the case of the recent sell off, there is a good argument that this was a result of specific country underlying fundamentals, such as Turkey and Argentina. This compares to countries such as India, which saw its economy grow 8.2% year-on-year in the second quarter of 2018, up 7.7% in the previous three months and beating market expectations of 7.6%. It is the strongest growth rate since the first quarter of 2016. Trading Economics reports that India has a bond yield of 8.13%. Similarly, Russia’s GDP Growth Rate is expected to be 0.50% by the end of this quarter. It is expected to stand at 0.20% in 12 months time and in the long-term, the Russia GDP Growth Rate is projected to trend around 0.90% in 2020, according to Trading Economics econometric models.

If you’re tempted to invest in EM debt be aware that accessing the debt isn’t easy. Granted, there are a number of ETFs in this area, but they don’t come cheaply and the variety isn’t huge.

Morningstar only rates two local currency ETFs with a Silver rating. The iShares JPMorgan EM Local Gov Bond ETF (IEML) (in USD) has had a return of -11.18% since the beginning of the year. Its sterling counterpart (SEML) had a return of -8.41%, so it’s clear what a strong dollar does. The ETF tracks the performance of the JP Morgan GBI-EM Global Diversified 10% Cap 1% Floor Index.

Below shows the difference of the ETF performance as a result of the currency; IEML is in black and SEML is in orange.

Source: Bloomberg

The other ETF that Morningstar rates as silver is the SPDR Bloomberg Barclays Emerging Markets Local bond ETF (EMDD). Again in USD it has returned -8.83% this year so far.

The local currency is something to take into consideration when investing in emerging market debt and hedging can help get around this. For UK investors when buying hard currency EM debt products you want to hedge into sterling, the same is true with ETFs and using the sterling version. As above, it can benefit on the returns.

The sell-off also shouldn’t put investors off, Morningstar Investment Management comments that emerging market local currency debt is considered one of the least over valued fixed income asset classes at the moment.

Below is a list of ETFs tracking emerging market debt listed on the LSE.

ETF TER YTD RTN INDEX
iShares J.P. Morgan USD EM Bond UCITS ETF

EEMB

0.45% -2.59% J.P. Morgan Emerging Markets Bond Index Global Core Index
iShares J.P. Morgan USD EM Bond UCITS ETF

SEMB

0.45% -2.09% J.P. Morgan Emerging Markets Bond Index Global Core Index
iShares J.P. Morgan USD EM Bond UCITS ETF

IEMB

0.45% -5.20% J.P. Morgan Emerging Markets Bond Index Global Core Index
iShares J.P. Morgan USD EM Bond UCITS ETF

EMHG

0.50% n/a J.P. Morgan Emerging Markets Bond Index Global Core Index
iShares JP Morgan EM Local Government Bond UCITS ETF

IEML

0.50% -11.29% JP Morgan GBI-EM Global Diversified 10% Cap 1% Floor Index
iShares JP Morgan EM Local Government Bond UCITS ETF

SEML

0.50% -8.13% JP Morgan GBI-EM Global Diversified 10% Cap 1% Floor Index
SPDR Bloomberg Barclays Emerging Markets Local Bond UCITS ETF

EMDD

0.55% -8.82% Bloomberg Barclays EM Local Currency Liquid Government Index
iShares J.P. Morgan USD EM Bond UCITS ETF

JPEA

0.45% -5.44% J.P. Morgan Emerging Markets Bond Index Global Core Index
PIMCO Emerging Markets Advantage Local Bond Source UCITS

EMLI

0.60% -11.5% PIMCO Emerging Markets Advantage Local Currency Bond Index
Xtrackers USD EM Bond Quality Weighted ETF

XQUA

0.40% & 0.50% -4.32% Markit iBoxx USD Emerging Markets Sovereigns Quality Weighted Index
Xtrackers II USD EM Bond ETF XUEM 0.25%

&

0.35%

n/a FTSE EM USD Government and Government-related bond select index
iShares J.P. Morgan USD EM Bond UCITS ETF

JPEE

0.45% -2.58% J.P. Morgan Emerging Markets Bond Index Global Core Index
FinEx Tradable Russian Corporate Bond ETF

FXRU

0.50% -2.87% Russian Corporate Euro Bonds
Fullgoal FTSE China Onshore Sovereign and Policy Bank Bond 1-10 Yr Index ETF

RMB1

0.40%

&

0.50%

0.91% FTSE China Onshore Sovereign and Policy Bank Bond 1-10 Yr Index

 

Lyxor iBoxx USD Liquid Emerging Markets Sovereigns ETF

LEMB

0.30% -6.19% iBoxx USD Liquid Emerging Markets Sovereigns Index
JPMorgan USD Emerging Markets Sovereign Bond UCITS ETF

JPMB

0.39% n/a Performance of bonds issued by the governments or quasi-government entities of EM countries globally denominated in USD
JPMorgan USD Emerging Markets Sovereign Bond UCITS ETF

JPBM

0.39% n/a Performance of bonds issued by the governments or quasi-government entities of EM countries globally denominated in USD
SPDR BoA Merrill Lynch EM Corporate Bond ETF

EMCB

0.50% 1.17% USD denominated EM corporate debt publicly issued in the US and domestic Eurobond markets
SPDR BoA Merrill Lynch EM Corporate Bond ETF

EMCO

0.50% -2.25% USD denominated EM corporate debt publicly issued in the US and domestic Eurobond markets
Van Eck Vectors EM High Yield Bond ETF

HYGB

0.40% n/a ICE BofAML Diversified High Yield US EM Corporate Plus Index
Van Eck Vectors EM High Yield Bond ETF

HYEM

0.40% n/a ICE BofAML Diversified High Yield US EM Corporate Plus Index
SPDR S&P EM Dividend ETF

EDVD

0.55% -6.88% S&P EM Dividend Opportunities Index