This bond ETF is down, but there’s lurking potential for a rebound

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En Wednesday, nearly all publicly traded U.S. fixed-income exchanges, regardless of underlying investment objective and geography, were in the red year-to-date.

The Federal Reserve probably did bond ETFs a disservice with a 50 basis point interest rate hike. On the other hand, it can be argued that the 50 basis point rise was not 75 basis points as some pundits expected, indicating that risk-tolerant investors might want to value certain segments at higher yield in the bond market.

This includes emerging markets and ETFs such as the American Century Emerging Markets Bond ETF (AEMB). As sure as the day is long, bonds issued by developing economies falter amid rising US interest rates. Investors who have been in the game for a while know that this scenario repeats itself, but this time it could be different. Really.

Due to the poor start to 2022 for emerging market bonds, many investors have visions of the taper tantrum of 2013, but 2022 and 2013 are no apples-to-apples comparison.

“Conditions today are very different, giving emerging markets much more resilience. A key component is foreign exchange reserves, which give a country a buffer to absorb any damaging impact from rising US rates. and strengthening of the greenback,” according to Morningstar research. “A rule of thumb for adequate foreign exchange reserves, as popularized by Fed Chairman Alan Greenspan in 1999, is that a country should manage its assets and liabilities so as to be able to survive without new foreign borrowing for up to a year, which translates to 7% of GDP. In 2013, 8 of 13 developing countries were well below this threshold, but by the end of 2020 only two were.

Specific to AEMB, the American Century ETF sports an option-adjusted duration of 7.1 years. This is mid-term territory and below some of the larger ETFs in this category. The AEMB is actively managed, so the interest rate risk can be reduced if necessary.

Another consideration is that many developing economies have significantly strengthened their fiscal positions since 2013.

“In 2013, among the most fragile countries, current account deficits averaged about 4.4% of GDP, down from just 0.4% in mid-2021, external resource flows had declined significantly, and rates real exchange rates were not as overvalued,” Morningstar added. .

Then there is the raw materials component. The AEMB allocates 38% of its weighting to bonds issued by Mexico, Indonesia, Colombia and Brazil, all of which are commodity-rich. This indicates that these countries are likely generating the revenue needed to service the debt, including the bonds held by the AEMB.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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