PCY: Dangerous Investment In Below Investment Grade Sovereign Bonds


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~ by Snehasish Chaudhuri, MBA (Finance)

Invesco Emerging Markets Sovereign Debt ETF (NYSEARCA:PCY) mostly invests in below investment grade emerging market sovereign bonds with very high maturity and duration. The weighted average maturity (WMA) stands at 20.6 years, while effective duration also is kind of high at 10.26 years. In an environment of rising rates of interest, sovereign bond prices are inclined to fall, and the degree of the autumn is higher on bonds with higher duration. As rates of interest increase, existing bonds turn out to be less worthwhile because their coupon payments turn out to be inferior to those of latest bonds being offered available in the market. Consequently, the market price of those older bonds decreases.

I tested my “Seven-Factor Model for Evaluating Emerging Market Bond Funds” on Invesco Emerging Markets Sovereign Debt ETF and located that this fund is a High-Risk Fund. The portfolio is overwhelmed by non-investment grade bonds and PCY undertakes risks which are disproportionate to its coupon income. Historically, the fund didn’t generate attractive total return for its investors, and is just not available at a superb discount either. The poor credit quality of its assets also raises suspicion over sustainability of its future yield. An in depth discussion will make it clear how PCY performed in those seven most important parameters.

The Invesco Emerging Markets Sovereign Debt ETF And Its Benchmark Index

Invesco Emerging Markets Sovereign Debt ETF is an exchange traded fund (ETF) launched and managed by Invesco Capital Management LLC. The fund invests in US dollar denominated government bonds of emerging economies with a remaining maturity of a minimum of three years. PCY has invested in 96 government bonds spread over 34 countries. An excellent thing is that this fund doesn’t make a high bet (by investing a high proportion of its assets) in a selected bond or bonds of a selected country. It has invested 3.4 percent of its assets in sovereign bonds of each Turkey and Oman. The utmost investment in a single bond -Turkey Government International Bond (900123AT7) – at present constitutes 1.19 percent of PCY’s total assets.

The Invesco Emerging Markets Sovereign Debt ETF benchmarks itself with the DBIQ Emerging Market USD Liquid Balanced Index. The Fund selects stocks from this index following a representative sampling approach. Consequently, the expense ratio is comparatively low at 0.5 percent. Nonetheless, that is still high for ETFs, on account of its passive nature of investment. The Index tracks the returns of greater than 100 US dollar-denominated government bonds issued by various emerging market economies. A crucial point to say here is that only just a few emerging market economies are chosen annually based on some statistical measure. Though the Index is rebalanced and reconstituted quarterly, it doesn’t represent a real reflection of performance of emerging market sovereign bonds. The historical performance of the underlying index has not been impressive.

PCY Failed To Generate Return In Long Term, Still Is Not Available At Discount

I analyze the investibility of emerging market bond funds by evaluating the seven most important aspects for such funds- stock price performance, AUM, annual average yield, level of portfolio diversification, average credit standing, current discount to NAV and future sustainability of its yield. As I choose funds only with prices higher than $5, yield higher than 5 percent and AUM of greater than $400 million, this fund is in my investment horizon. PCY’s stock is currently trading just like its net asset value (NAV) of $18.4, and thus investors won’t have the opportunity to purchase it at a big discount.

The Invesco Emerging Markets Sovereign Debt ETF has been paying monthly dividends for the past 15 years. It generated a good annual average yield mostly between 4 to five percent. This yr, nevertheless, the yield is kind of high at 6.4 percent, primarily on account of an enormous drop in its market price. PCY’s share fell by almost 30 percent in 2022. Price performance has also been unimpressive within the remaining years. Despite decent annual average yields, the fund generated a median total return of only 0.3 percent through the past 10 years. Inside this era, PCY generated double digit total return just once – in 2019. I do not think any investor shall be attracted by this return over such a protracted time period. Along with all these, this emerging market fund undertakes very high risk.

PCY Is A High-Risk Fund, Which Raise Suspicion About Sustainability Of Yield

Although PCY is an emerging market fund, it invests only in 20 markets. The fund has invested lower than 9 percent within the BRICS economies, while a few of its sovereign bond investments are very dangerous on account of higher probability of defaults. Sovereign bonds of Angola, El Salvador, Nigeria, and Pakistan are rated below B, by which PCY has invested greater than 10 percent of its assets. Furthermore, almost 65 percent of PCY’s investments are in non-investment grade bonds, i.e. those bonds are rated below BBB. For my part, this portfolio is neither truly diversified neither is shielded from default risk.

The yield appears to be sustainable in the primary instance, since the portfolio of investments is generating a median coupon of 5.73 percent. Nonetheless, it’s sustainable provided that there isn’t any default. As discussed earlier, it’s difficult to ensure zero default, as among the investments involve very high risk. The fund has undertaken disproportionate risk with a purpose to ensure its coupon income. For my part, the coupon is not high enough to justify an investment of 65 percent in non-investment grade sovereign bonds. With respect to highly dangerous investments, the fund has invested in 12 sovereign bonds of Angola, El Salvador, Nigeria, and Pakistan on a coupon ranging between 6 to 9.4 percent. Such investments are not a clever decision given the iffy nature of a few of these economies.

Investment Thesis

Invesco Emerging Markets Sovereign Debt ETF is an emerging market sovereign debt fund from Invesco Capital Management that invests heavily in below investment grade government bonds with relatively high duration. PCY is a sturdy fund, has an AUM of $1.43 billion, trailing twelve-months (TTM) yield of 6.9 percent, and is currently trading at $18.4. Nonetheless, in keeping with my “Seven-Factor Model for Evaluating Emerging Market Bond Funds”, PCY didn’t generate attractive total return for its investors, and undertook risks which are disproportionate to its coupon income. Its portfolio cannot be labeled as a very diversified emerging market portfolio. The poor credit quality of its assets also raises suspicion over sustainability of its future yield. The fund is just not available at a reduction to its NAV. I do not find reason to be bullish about this fund and assign a sell suggestion.

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