ETF Spotlight: Emerging Markets Sovereign Debt Portfolio (PCY)
While equity ETFs may be the most popular choice among investors, the fixed income fund universe has expanded tremendously over the years, offering investors exposure to a wide array of bond types and issuers. While fixed-income exposure is a key component of any long-term, buy-and-hold portfolio, most funds only focus on U.S. bonds. In this piece, we highlight a compelling fund, which offers investors exposure to an attractive and lucrative corner of the foreign fixed income market [see also How to Build an Income Portfolio with ETFs: Insights from David Fabian].
The PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) offers investors access to a broad portfolio of emerging market fixed income securities. PCY tracks the DB Emerging Market USD Liquid Balanced Index, which tracks the potential returns of a theoretical portfolio of liquid emerging markets U.S. dollar-denominated government bonds issued by approximately 22 emerging-market countries. To be included in the index, securities must meet the following requirements:
- Denominated in U.S. dollars
- Are sovereign bonds
- Have at least three years to maturity
- Have an outstanding float of at least $500 million.
Investors should note, however, that PCY utilizes a sampling methodology, which means it does not hold all of the securities in the underlying index. The fund is rebalanced and reconstituted quarterly [see also Using ETFs to Get Emerging Market Exposure].
Under the Hood of PCY
PCY’s portfolio consists of over 60 fixed income securities, the majority of which hold a credit rating of BBB or higher and and maturities of 5 to 25 years. Unlike many emerging market products, PCY takes a more balanced approach to country exposure, meaning it is not overly biased towards one particular country.
The fund’s underlying index only includes bonds issued by the governments of Brazil, Colombia,Croatia, El Salvador, Hungary, Indonesia, Latvia, Lithuania, Mexico, Panama, Peru, the Philippines, Poland, Qatar, Romania, Russia, South Africa, South Korea, Turkey, Ukraine, Uruguay and Venezuela. PCY’s resulting portfolio features no more than a 5% allocation to these emerging market governments [see also Bond ETFs for Every Objective].
What further distinguishes PCY is that it also does not overweight a single security or a small group of securities; for example, its top holding is allocated less than 3% of total assets.
Considerations on PCY Performance
As with any foreign investment, investors will need to be conscious of currency risk, given that PCY invests in U.S. dollar-denominated bonds, meaning this fund may be best suited for those who are bullish on the U.S. dollar. If you are not comfortable with this currency risk, you may want to consider ETFs that offer exposure to emerging market bonds issued in local currencies, such as:
- Market Vectors Emerging Markets Local Currency Bond ETF (EMLC)
- Emerging Markets Local Debt Fund (ELD)
- iShares Emerging Markets Local Currency Bond ETF (LEMB)
- Emerging Markets Local Currency Bond ETF (FEMB)
Another consideration is the fund’s credit risk: emerging market governments are not as stable as developed economies, and therefore have a higher probability of default.
In general, any investment in emerging markets carries a higher level of risk, because of these governments’ fragility. Investors may see relatively larger price swings of PCY, as apposed to a U.S. government bond ETF. These prices swings could be driven by a number of factors including geopolitical events, monetary policy, or any other internal or external shocks [see also Controlling Risk with ETFs].
How to Use PCY in a Portfolio
The PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) is best suited for investors looking for both an attractive stream of current incomes and lucrative growth opportunities, while at the same time being able to tolerate the risk associated with this fund. PCY is best used as a complementary holding, instead of a core holding, given its higher level of risk.
One of the best features of PCY is that it makes monthly distributions, and has been doing so consistently since its launch in 2007. Investors should note, however, that the payment amounts do often change each month.
The Bottom Line
PowerShares’ PCY is one of the most successful and widely-used Emerging Markets Bonds ETF on the market. Its balanced portfolio, unique exposure, monthly distributions, and relatively low cost make it a compelling buy for those wanting to add exposure to this popular corner of the bond market.
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Disclosure: No positions at time of writing.