Why emerging market sovereign debt outperformed US Treasuries

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Emerging market sovereign debt

Sovereign bond funds (PCY) have provided higher returns compared to U.S. Treasuries (IEF) over the past year. Year-to-date (or YTD), they have also provided higher returns compared to the S&P 500 Index (IVV).

Part 8

The PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) and the iShare International Treasury Bond ETF have clocked 11.6% and 10.4%, respectively, in returns over the past year. This compares to 6.55% in total returns earned by the iShares 20+ Year Treasury Bond ETF (TLT) and 3.1% in total returns for the iShares 7–10 Year Treasury Bond ETF (IEF).

The iShares JPMorgan USD Emerging Markets Bond ETF (EMB) which has U.S. dollar-denominated holdings in both sovereign and corporate debt, has returned 10.7%. Return comparisons for emerging market bond funds have been favorable over the past three to five years.

All the exchange-traded funds (or ETFs) compared in the graph above, have holdings in only investment-grade debt. However, sovereign borrowers in emerging markets are typically lower-rated compared to U.S. Treasuries. As a result, they provide higher yields. U.S. Treasuries (TLT) are considered to be some of the safest assets in the world. They are rated AAA by Moody’s—the highest possible rating—and AA+ by Standard & Poor’s (or S&P) and Fitch.

U.S. government debt downgrade

The debt ceiling on U.S. debt had been reached. Democrats and Republicans were wrangling in order to raise the debt limit. In August, 2011 Congress voted to raise the debt ceiling. The S&P downgrade of U.S. debt followed. The ratings were revised from AAA—the highest level—to AA+.

A debt ceiling sets a limit on the maximum amount the government can borrow under existing laws. A higher borrowing ability would reduce the government’s ability to make the payments.

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