Ukraine has lost a bit of the world’s attention in the past month as the most worrisome international hot spot for investors due to the boiling conflict in Iraq. But that doesn’t mean there aren’t opportunities in Mother Russia’s harried neighbor for exchange-traded fund (ETF) and mutual fund investors looking to emerging market bonds to potentially boost returns. (For more on this topic, see: An Introduction To Emerging Market Bonds.)

Emerging market bond ETFs and mutual funds buy bonds issued by the governments of fast growing economies of countries in Asia, South America and Eastern Europe, including Hungary and Ukraine. Countries issue the bonds in either local currencies or in debt that is dollar-denominated. Investor demand for emerging market debt has increased significantly over the last several years due to improving fundamentals in these countries and relatively higher yields. (For related reading, see: Should You Invest In Emerging Markets?)

Hunting for Yield

The U.S. Federal Reserve’s bond buying program has also boosted yield-starved investor interest in emerging market debt. The flip side to the Fed’s bond buying policy is tapering, and emerging markets are extremely sensitive to the taper. Concerns last year about the effect of the tapering of the Fed’s bond buying program caused extreme volatility in those markets. Emerging markets bond funds saw an average decline of 7% last year, according to fund tracker Morningstar.

A handful of ETFs and mutual funds provide investors with exposure much greater than their peers to Ukrainian dollar-dominated bonds. Many emerging market debt managers have avoided Ukraine due to fears of Russia's continued harassment. One longtime global bond manager, Michael Hasenstab, is taking a contrarian view on Ukraine, a country that has seen its fair share of turmoil in the past year. (For related reading, see: Investing Like a Contrarian.)

Pick Selectively

“Ukraine’s a country that we’ve been interested in for a number of years and we’ve picked our spots selectively,” Hasenstab recently said in an interview. “Over the last couple of years, Ukraine has gone through periods when they’re out of favor with the market and you’ve had panic selling and spikes in yields, and so we have cherry-picked those opportunities to accumulate a position.”

“What attracted us to it was – on the solvency side – Ukraine has very little debt,” said Mr. Hasenstab, who is the manager of the giant $72 billion Templeton Global Bond A fund (TPINX), which is up about 2% for the year. Its long-term performance is more impressive; for the past 12 months the fund is up 4.3%, while over five years it is up 13.6%.

“As a dollar-based investor, we’re not taking foreign-exchange risk, we’re taking dollar-denominated Ukrainian government bonds in a country that has 40% debt-to-GDP,” Hasenstab said. “It was never a solvency issue. It was more one of liquidity, and recently with the IMF package, international aid support, Ukraine will access over the next couple of years, because of their good reform agenda, over $30 billion of international assistance.

Hasenstab believes that the Ukraine’s recent crisis and Russia taking control of the Crimea has spurred economic reforms that – in three to five years – will improve Ukraine’s credit.

While Hasenstab draws attention for being enamored with such a hot spot, others do agree with his long-term assessment of Ukraine.

Bond Breathing Space

“Vital breathing space was given to the Ukrainian government at end of March, when a two year International Monetary Fund program with up to $18 billion was agreed as part of a wider international funding with the potential to reach $27 billion,” recently noted Aberdeen Asset Management. “It is expected that this amount should be large enough to stabilize the currency and the country’s banking system.”

And Hasenstab is making good on his belief in Ukrainian debt. TPINX has 7.3% of the portfolio’s bonds in Ukrainian debt; the average world bond fund has barely 0.57% allocated to Ukrainian debt, according to Morningstar. For even greater exposure to Ukraine, investors can take a look at another fund Hasenstab co-manages, the Templeton Emerging Markets Bond A fund, (FEMGX). That fund currently has 12.59% of its bonds in Ukraine, while the average emerging markets bond fund has just 1.3%. (For related reading, see: 4 Misconceptions That Sink Emerging Market Investors.)

A Pair of Funds To Consider

ETF investors interested in exposure to Ukraine should consider two funds, the iShares Emerging Markets High Yield Bond fund, (EMHY) and the Pro Shares Short Term USD Emerging Markets Bond ETF, (EMSH). With $206 million in total assets, EMHY has 2.6% of its bonds in Ukraine – about twice the average emerging markets bond ETF.

For investors who are more enamored with the argument to buy Ukrainian debt, EMSH may be a better fit, although it is tiny, with just $12.3 million in total assets. But with 8.7% of its bonds in Ukrainian debt, EMSH has six-and-a-half times the exposure to Ukraine than the average emerging markets ETF.

Emerging markets debt investors willing to increase or take on exposure to the Ukraine should have patience, according to Hasenstab. Ukrainian debt was trading in the mid-80s earlier this year but bonds have rebounded. Many are close to par now. “It’s a volatile market; it ebbs and flows on a day-by-day basis,” he said. “But I think we’ve seen a lot of naysayers – a lot of short-sellers out there – that have realized that was a mistake.”

“Our objective is to position for a three- to five-year horizon, when ultimately underlying macroeconomic fundamentals will determine market prices,” Hasenstab said. “We have the benefit of that long-term horizon, which allows us to ride through periods of short term volatility.”

The Bottom Line

Looking beyond current violence and unrest, Ukraine presents some compelling reasons for adventurous emerging markets investors who don't mind a little geopolitical risk. It's strong balance sheet means that once political stability returns, Ukraine could become an attractive destination for investors. The time to get in - and get in relatively cheaply - could be now.

Related Articles
  1. Investing

    Where the Price is Right for Dividends

    There are two broad schools of thought for equity income investing: The first pays the highest dividend yields and the second focuses on healthy yields.
  2. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  3. Investing

    The Pros and Cons of High-Yield Bonds

    Junk bonds are more volatile than investment-grade bonds but may provide significant advantages when analyzed in-depth.
  4. Chart Advisor

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  5. Mutual Funds & ETFs

    Buying Vanguard Mutual Funds Vs. ETFs

    Learn about the differences between Vanguard's mutual fund and ETF products, and discover which may be more appropriate for investors.
  6. Mutual Funds & ETFs

    ETFs Vs. Mutual Funds: Choosing For Your Retirement

    Learn about the difference between using mutual funds versus ETFs for retirement, including which investment strategies and goals are best served by each.
  7. Mutual Funds & ETFs

    How to Reinvest Dividends from ETFs

    Learn about reinvesting ETF dividends, including the benefits and drawbacks of dividend reinvestment plans (DRIPs) and manual reinvestment.
  8. Stock Analysis

    What Exactly Does Warren Buffett Own?

    Learn about large changes to Berkshire Hathaway's portfolio. See why Warren Buffett has invested in a commodity company even though he does not usually do so.
  9. Economics

    Will Putin Ever Leave Office?

    Find out when, or if, Russian President Vladimir Putin will ever relinquish control over the Russian government, and whether it matters.
  10. Financial Advisors

    Ditching High-Yield Bonds for Plain Vanilla Ones

    In a low-rate environment, it's tempting to go for higher yield bonds. However, you might be better off sticking with the plain vanilla ones.
  1. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  2. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  3. What are the maximum Social Security disability benefits?

    The average Social Security disability benefit amount for a recipient of Social Security Disability Insurance (SSDI) in 2 ... Read Full Answer >>
  4. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  5. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  6. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>

You May Also Like

Trading Center