An Emerging Market Income Idea If The Fed Lowers Rates

The Federal Reserve meets this weeks and expectations are in place for an interest rate cut. Whether it's 50 basis points or 25 basis points, that remains to be seen, but what is clear is that high-yielding assets have been in style this year amid hopes the Fed will trim borrowing costs.

What Happened

Among the income-generating assets that stand to benefit from lower U.S. interest rates are emerging markets bonds and the related exchange traded funds, such as the Invesco Emerging Markets Sovereign Debt ETF PCY.

PCY, which tracks the DBIQ Emerging Market USD Liquid Balanced Index and holds dollar-denominated emerging markets debt, is up 11.39% this year.

PCY's index “tracks the potential returns of a theoretical portfolio of liquid emerging markets US dollar-denominated government bonds issued by more than 20 emerging-market countries,” according to Invesco.

Why It's Important

The Invesco ETF has a 30-day SEC yield of 4.76%, or more than double what investors get on 10-year Treasuries, to the allure of the product is understandable for income-hungry investors.

“Currently, it appears there are very few places to generate yield, with 10-year rates in the Eurozone at negative 0.30%, and Japan at negative 0.15% and the US 10-year hovering around 2%, as of July 22, 2019,” said Tim Urbanowicz, Invesco Senior Fixed Income ETF Strategist, in a recent note. “Enter emerging markets (EM): as of July 22, 2019, Invesco Emerging Markets Sovereign Debt ETF (PCY), has an SEC 30-day yield of 4.80%, an effective duration – or measure of a bond’s sensitivity to changes in interest rates –  of 9.32 years, and 45% of the portfolio rated investment grade.”

PCY is almost 12 years old and unbeknownst to many investors, the fund is one of the original smart beta fixed income ETFs owing to its equal-weight methodology. Said another way, PCY limits both geographic and issue risk through equal weighting. None of the fund's country weights exceed 2.79% and none of its 116 holdings exceed weights of 1.16%.

What's Next

Historical data confirm that a rate cut could in fact be a boon for PCY.

“If we look at the last four easing cycles, USD EM debt has rallied an average of 9.5% in the 6 months following the first Fed cut, which makes a strong case for PCY,” said Urbanowicz.

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