With more exchange traded fund options now available, fixed-income investors can expand their portfolios to include emerging market debt exposure. However, not all ETFs are created equal, so potential investors should review the various offerings before diving in.
For starters, some of the first emerging market bond ETFs to hit the market are denominated in U.S. dollars, writes Morningstar analyst Karin Anderson.
“While investors aren’t exposed to the currency risks of the underlying issuers, they are taking on credit risk stemming from political, regulatory, or market developments,” Anderson said.
For example, the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) tracks U.S dollar-denominated government bonds issued by emerging countries. Investors will be exposed to risks associated with the more volatile emerging markets and lower-rated countries, but the fund does hold investment-grade quality debt as well, including AA 2.8%, A 10.1% and BBB 42.2%.
Investors can also browse through a number of local-currency emerging market bond ETFs, which expose investors to the currencies of the underlying issuers. For instance, the Market Vectors Emerging Markets Local Currency Bond ETF (EMLC) tracks a basket of local currency bonds issued by emerging market governments.
Anderson points out that local currency funds “have shorter maturities and shorter durations and are therefore less sensitive to changes in interest rates.” EMB shows an average effective duration of 7.13 years while EMLC has a duration of 4.48 years.
On the other hand, local-currency debt have experienced greater swings than USD-denominated debt. [Asia Bond ETFs Seen as Vulnerable as Debt Rises]
“It’s clear that local-currency options are the most volatile way to invest in this asset class,” Anderson said. “Over the past five years through July 31, 2014, the typical local-currency fund experienced 1.4 times as much volatility (as measured by standard deviation) as the average hard-currency offering.”
Moreover, retail investors are now able to access emerging market corporate debt through dedicated emerging market ETFs, like the WisdomTree Emerging Markets Corporate Bond Fund (EMCB) . EMCB, like other corporate bond fund offerings, tend to track USD-denominated due to legal restrictions and poor custody arrangements in the local markets.
Lastly, investors can choose from fund that have a mix of debt options. The Market Vectors Emerging Markets Aggregate Bond ETF (EMAG) follows sovereign and corporate debt denominated in USD, euros and local emerging market currencies.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.