Investing in emerging markets has become a little dicey at present, largely thanks to taper concerns in the U.S. market. However, after a rough patch in 2013, most emerging market funds seem to have stabilized to start this year, and especially so in the bond space.
Amid such a backdrop, EGShares came up with three new funds in the emerging market (EM) bond space across the duration spectrum in association with mutual fund provider TCW. These include the following funds, all of which hit the market on January 8th; EGShares TCW EM Short Term Investment Grade Bond ETF- SEMF, EGShares TCW EM Intermediate Term Investment Grade Bond ETF- IEMF and EGShares TCW EM Long Term Investment Grade Bond ETF- LEMF.
SEMF, IEMF & LEMF in Focus
These new passively managed ETFs look to track the J.P. Morgan Custom EM short-term, medium-term and long-term Investment Grade Bond Indexes. Each of the funds charges 65 bps in fees which is a bit costlier, though still in line, in the EM bond space.
All of these funds are of high credit quality and denominated in U.S. dollars. The fund may invest only 20% of assets in non-investment grade debt securities. The ETFs will have exposure in both sovereign and corporate bonds.
The distinction lies in the maturity period and number of holdings. For SEMF, the index is exposed to 48 emerging markets bonds with maturities between 1 and 3 years.
For IEMF, the index comprises 118 EM investment grade sovereign and corporate bonds with outstanding maturities between 4 and 7 years while LEMF seeks to match up the performance 121 EM bonds with a targeted total duration exposure between 8 and 12 years (read: 5 ETF Predictions for 2014).
Each fund will cap the exposure of a single country to 20% of the total assets. Countries likely to rule the fund are Brazil, Chile, China, Colombia, Czech Republic, Hungary, India, Indonesia, Malaysia, Mexico, Peru, the Philippines, Poland, Russia, South Africa, Thailand and Turkey.
How do these fit in a portfolio?
For investors who remain yield-starved in a rock-bottom interest rate environment in the developed nations, but are still looking for a fixed-income play, these EM products might be enticing options.
Though a modest QE tapering is slated for this month and more of it is probably in the cards, the Fed has vowed to keep the interest rate low for longer. And if the Fed succeeds in accomplishing this goal, U.S. Treasury bond yields will remain low even after the taper is executed (read: 3 Bond ETFs Popular in the 'No Taper' Aftermath).
Let’s consider the bear-case scenario as well. If the U.S. treasury yield starts rising (which is happening at present), it will still remain low compared to emerging market bond yields.
Moreover, emerging market equities will remain out of favor in 2014 due to the lack of cheap money. Historically noticed, that bonds remain have been less volatile than equities. Thus, EM bonds look better-placed than their equities cousins in 2014.
The return profile validates the fact. While broader emerging market equity ETFs iShares MSCI Emerging Markets ETF (EEM) and Vanguard FTSE Emerging Markets ETF (VWO) lost respectively 3.98% and 4.08% in the last one month, bond ETFs like iShares JPMorgan USD Emerging Markets Bond Fund (EMB) and PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) gained, respectively, 1.30% and 2.16%.
Lastly, through these new-launched funds, investors can resort to higher yields while not being open to default risk. In most cases, yield-seeking investors have to bear the pain of poor credit quality of the underlying assets in the fixed-income market.
Additionally, since these funds are zeroing in on dollar-denominated bonds, there is little cause for concern if the foreign currencies tumble against the dollar (read: 3 Currency ETFs Crushed in Emerging Market Rout).
The space is still under-tapped with EMB, PCY and WisdomTree Emerging Markets Local Debt Fund (ELD) topping the list of highest AUM gatherers. However, the newly launched ETFs presumably will not face much trouble in obtaining investor money.
In fact, the third biggest fund, ELD, has exposure in local currency making it a bit risky option in the current environment. Plus, very few bond funds currently offer exact duration exposure, setting these apart.
Therefore, in order to show up in the space, SEMF, IEMF and LEMF will have to promote their targeted duration, investment grade and currency exposure, which will set the trio apart from most of the other products in this still small space.
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