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An Evolving Emerging Markets Bond ETF

ETF Professor

Emerging markets stocks aren't the only asset class offering exposure to developing economies getting drubbed this year. Bonds are, too. The J.P. Morgan EMBI Global Core Index, a widely followed gauge of dollar-denominated emerging markets debt, is lower by nearly 6 percent year-to-date.

Some exchange traded funds focusing on developing world bonds are sporting larger year-to-date losses, highlighting the need for investors to evaluate the various weighting methodologies for funds in this asset class.

What Happened

The WisdomTree Emerging Markets Local Debt Fund (NYSE: ELD) is an actively managed fund. ELD turned eight years old in August, so the fund has seen its share of trying environments for emerging markets debt.

ELD's methodology is “focused on continuous risk management and offers high income potential, diversification, and total return through combination of Emerging Market interest rates and currencies,” according to WisdomTree.

ELD's approximately 130 holdings are denominated in local currencies, many of which have tumbled this year as the U.S. dollar has rallied.

Why It's Important

At a time of dollar strength and related struggles for emerging markets bonds, ELD is changing how it goes about its business. That includes shifting geographic allocations.

“Shifting geographic allocations along with variability in weights means that the characteristics of the asset class evolve frequently, particularly during volatile markets,” said WisdomTree in a note out Monday. “In our view, incorporating fundamentals into our selection process provides a more intuitive approach than simply owning countries that have issued the most debt. Similarly, we are also able to maintain the flexibility to include EM countries like China, India and South Korea, which, despite their importance to global markets, receive no weight in the benchmark.”

ELD's selection universe is comprised of the following markets: Brazil, Chile, Colombia, Mexico, Peru, Poland, Romania, Russia, South Africa, Turkey, China, Indonesia, Malaysia, Philippines, South Korea and Thailand.

Brazil and Mexico, Latin America's two largest economies; and Indonesia combine for roughly a third of the fund's weight.

What's Next

Since inception, ELD has been notably less volatile than some of the major emerging markets debt indexes. That is a point to consider for investors mulling emerging markets bonds in the current environment.

“While there is no guarantee that this historic relationship will always hold, we believe our bias to fundamentals and new tiering structure could provide a more intuitive approach to EM fixed income going forward,” said WisdomTree. “With the vast majority of EM currencies off close to 10% year-to-date,4 now could be a good time for investors realizing losses in other EM debt strategies to consider reallocating to our fundamentally weighted approach.”

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