Emerging market bond ETFs have been raking in assets this year as investors grow optimistic about the outlook for developing economies, and hone in on the attractive yields the region offers.
This is a pocket of fixed income that was bruised and battered following last November’s U.S. presidential election due to concerns about inflation, higher rates and the possibility of a strong dollar under the new administration.
But in 2017, emerging market bond ETFs have staged quite a turnaround. A recent Columbia Threadneedle survey gauging investor sentiment toward emerging markets in general showed a “significant” uptick in how investors feel about the region—up 36% from the last quarter of 2016, and up 72% from the end of 2015.
Emerging market equities have been hot this year; emerging market bonds too. The five largest EM bond ETFs have seen solid net inflows in 2017—and represent only a quarter of the number of emerging market bond ETFs in the market today.
iShares JP Morgan USD Emerging Markets Bond ETF (EMB), the largest ETF in the segment, with $11.7 billion in total assets, has attracted $3.3 billion in net creations so far in 2017.
PowerShares Emerging Markets Sovereign Debt Portfolio (PCY), with $4.7 billion in total assets, has gathered $786 million this year.
VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC), with $4.1 billion in total assets, has gathered more than $1.4 billion in fresh net assets.
Vanguard Emerging Markets Government Bond ETF (VWOB), with $1.0 billion in total assets, has attracted $95 million in net inflows.
iShares Emerging Markets High Yield Bond ETF (EMHY), with $515 million in total assets, has raked in $403 million in net creations year-to-date.
Mark Dow, founder of Dow Global Advisors, has long been sounding the horn about the opportunity in emerging markets through the fixed income lens. For more than year, Dow has argued that currencies had gotten stretched on the downside, and that the region is in the process of forging a bottom as fundamentals get stronger.
Unlike equities, which need growth to really move higher, emerging market bonds offered a good entry point to the emerging-market-recovery story, thanks to their good risk/reward in the form of carry and interest, particularly local-currency bonds. (You can read one of Dow’s interviews on the subject here.)
“The really good entry points on emerging market local currency bonds are probably behind us, but the asset class it still very attractive to hold or to add to in sell-offs,” Dow said. “There’s still very good scope for emerging market currency appreciation over the next few years, and investors are desperate for yield.”
Yields & Performance
Consider, for example, that EMLC, a fund that owns debt issued by more than 20 EM governments denominated in local currencies, is offering a 30-day yield of 5.5%. The fund’s effective duration—a measure of how sensitive a bond’s price is to changes in interest rates—is five years.
EMB, which removes the foreign exchange volatility from the mix by investing in U.S.-dollar-denominated sovereign debt issued by emerging market countries, has a 30-day yield of 4.5% in a portfolio with effective duration of about seven years.
For comparison, the iShares Core U.S. Aggregate Bond ETF (AGG), which owns U.S. investment-grade debt, and has effective duration of about 5.6 years, is shelling out a 30-day yield of only 2.2%.
And look at the year-to-date performance of these three strategies relative to one another. Emerging market bonds, particularly local currency, are delivering solid upside:
High-Yield EM Bonds
In the high-yield space, investors are getting a 30-day yield of 5.2% in a portfolio with effective duration of 5.5 years in EMHY. The fund owns U.S.-dollar denominated high-yield debt from emerging market governments and companies led by a 22% allocation to Brazil and 11% to Turkey.
They are also getting outperformance relative to US. high-yield strategies such as the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the largest U.S. high-yield bond ETF—albeit a fund that owns only corporate bonds. HYG has a 30-day yield of 4.8%, with effective duration of 3.5 years.
Outlook Positive But Selective
“Investors have been hunting for yield in global credit and EM debt markets due to ongoing central bank QE and negative rates in much of the developed world,” BlackRock said in its most recent global outlook.
Making a case for “selective” bond investing, the giant asset manager added: “We like selected EM debt. Global growth favors the asset class, even if the Fed is raising rates. We see further capital gains as limited after a big run-up, and focus on income as the main source of returns.”
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