Emerging-Markets Debt Is Still Cheap

 | Jun 07, 2012 | 11:30 AM EDT
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On Wednesday morning, a lot of asset classes looked quite cheap after a prolonged slump sent major indices sharply lower. But one huge pop later, bargains are a bit harder to come by. With global stock markets rallying by close to 3% yesterday, it's suddenly much more difficult to identify opportunities with potential to post solid returns over the next few months.

There is, however, one asset class that still stands out as a bargain: emerging-markets debt. The shares prices of ETFs that hold bonds of issuers in developing markets have dropped quite a bit recently, pushing up yields in the process and creating an attractive entry point. The WisdomTree Emerging Markets Local Debt Fund (ELD), which has shed about 4% of its value over the past four weeks, now boasts a 30-day SEC yield of about 4.7%. That's quite appealing in any environment, and there exists the potential for that return to be enhanced dramatically by some additional factors.

I've written about the general appeal of emerging-markets debt quite a bit over the last year; it offers a way to capture attractive yields from debt that features relatively low credit risk. Emerging markets now have generally strong balance sheets, and they should be able to repay their obligations much more easily than the cash-strapped borrowers in Europe and even in the U.S.

The risk premium in emerging-markets debt over U.S. Treasuries is a remnant of the global economy of yesteryear, when obligations of the U.S. government offered a truly risk-free return and emerging markets were huge credit risks full of geopolitical uncertainty and shaky fiscal footing. Now, U.S. Treasuries have become the return-free risk, while emerging-market coffers lined with cash make them one of the safest investments available.

I always keep a close eye on emerging-markets debt when stock markets slide, because those declines tend to create attractive buying opportunities due to the continuing safe-haven appeal of the U.S. dollar. When stock markets encounter turbulence, the greenback sees a surge in interest, which, in turn, diminishes the value of debt-denominated in other currencies to U.S. investors and sends ETFs such as ELD down sharply.

The compelling case for investing in debt of emerging-markets issuers is based in large part on the currency-related tailwinds that should enhance returns to U.S. investors over the next several years. You'll get little argument from a prediction that the U.S. currency is destined to decline compared to the currencies of developing economies in Asia and South America over the long haul. But when anxiety over the global economy jumps, investors flock to the dollar and emerging-market currencies depreciate. Therein lies the opportunity; if the dollar comes back to earth eventually, ETFs such as ELD will benefit from the favorable exchange-rate movement.

I'm not in the business of forex trading or predicting short-term swings in the value of the Indian rupee or Brazilian real, but I'm pretty confident in the long-term prospects of those currencies relative to the dollar and happy to buy into potential appreciation when prices are low.

ELD is one of the few good opportunities out there after Wednesday's spike; give this ETF a look if you're still shopping for bargains and/or current yield.

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