Investors Sticking By EM Junk Bond ETFs...For Now

All the chatter about rising interest rates has not done much to help high-yield bonds this month. Junk bonds, favored by investors not only for high yields, but for lower durations that make the bonds less sensitive to interest rate risk, are headed for a monthly decline.

The 21 primary dealers that work with the Federal Reserve increased their positions in junk debt by $2.7 billion to $8.5 billion for the three weeks ending May 22, Bloomberg reported. That same Bloomberg piece astutely notes that issuance is soaring, as in companies issued $44.1 billion in high-yield debt for the three weeks ending May 22.

Broadly speaking, that has not been good for the asset class as U.S. junk bonds are headed for their first monthly loss in a year. As for ETFs, the two largest junk bond funds, the iShares iBoxx $ High Yield Corporate Bond Fund HYG and the SPDR JNK, are likely to finish down about one percent this month.

High-yield debt courtesy of emerging markets issuers has been noticeably worse in May. The iShares Emerging Markets High Yield Bond Fund EMHY and the Market Vectors Emerging Markets High Yield Bond ETF HYEM are both in position to have May losses of more than 2.5 percent.

Investors are not dumping emerging markets high-yield debt, at least not as measured by EMHY and HYEM. At least not yet. HYG and JNK are by far the two largest junk bond ETFs by assets and as such, control the bulk of the attention paid to ETFs tracking this asset class. In other words, investors have probably heard that money has been flowing out of these funds. JNK has seen second-quarter outflows of over $1.2 billion while HYG lost $324.3 million as of May 30.

EMHY and HYEM have been pulling in new assets over the same time. EMHY, the iShares offering, has attracted almost $11 million in new assets since April. HYEM has pulled in almost $199 million of its $243.6 million in assets under management since the start of the second quarter, according to Index Universe data.

Not Much Attention
Neither EMHY nor HYEM are particularly old ETFs. Combine that with the fact that the concept of emerging markets high-yield is a new one to many U.S. investors, particularly on the retail side, it is not surprising that these two ETFs do not garner a lot of headlines. Both have been impressive asset gathers in a short amount of time

EMHY debuted in April 2012 and now has $256.1 million in AUM. HYEM is a month younger and has almost $244 million assets.

Those superlatives have not insulated the ETFs from being beaten up along with their more popular counterparts that track emerging markets sovereign debt. As fears of rising interest rates and the end of quantitative easing have spiked, emerging markets bond ETFs, both the dollar-denominated and local currency funds, have been pounded.

For example, the Market Vectors EM Local Currency Bond ETF EMLC is off five percent this month while the dollar-denominated iShares J.P. Morgan USD Emerging Markets Bond Fund EMB is down 4.5 percent.

Advantages
Emerging markets junk bond funds do hold some advantages of their U.S.-focused peers and that may be what is stemming outflows. In the case of EMHY, the ETF offers the potential for capital appreciation through its 28 percent combined weight to Turkey and the Philippines.

Those countries have been on the receiving end of multiple credit ratings upgrades this year and that could prove important to EMHY going forward because the fund focuses on high-yield sovereigns, not corporates.

HYEM, the Market Vectors fund, is more comparable to HYG or JNK due to its focus on corporate issues and quasi-sovereigns. Statistics indicate HYEM compares favorably with an ETF like JNK. JNK has a 30-day SEC yield of 4.62 percent, an average yield to worst of 5.4 percent and a modified adjusted duration of 4.28 years. For HYEM, those numbers are 5.78 percent, 6.57 percent and 4.4 years.

There also is not a significant trade-off in credit quality. Roughly 83 percent of JNK's holdings are rated BB or B, according to State Street data. The same is true of HYEM.

It is also worth noting the BofA Merrill Lynch High Yield US Emerging Markets Liquid Corporate Plus Index, the index HYEM uses for its sampling strategy, has a higher yield than the equivalent U.S. junk bond and emerging markets sovereigns indexes, according to Market Vectors.

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