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ETF News And Commentary

With the “safer” US fixed income instruments such as Treasury bonds and high-grade corporate bonds yielding meager returns, many income oriented investors now prefer to look towards emerging markets for additional income in their fixed income portfolios. Further due to their low correlation with the developed markets, exposure to these markets adds significant diversification benefits to a fixed income portfolio.

Emerging markets currently represent about one-third of global GDP and their share will continue to grow in the coming years. As such they should be a part of any investment portfolio. Most investors should consider about 10% to 30% (depending on their risk tolerance) allocation to emerging markets in their fixed income portfolios.  (See more on ETFs at the Zacks ETF Center).

Emerging market bonds generally have a higher risk than developed market bonds, which is offset by higher yields that they offer. However, the risk profiles seem to be improving as many emerging market countries now have a better fiscal health than the developed countries. Additionally, for most countries inflation risk seems to be declining.  (Read: Go Local With Emerging Market Bond ETFs)

When considering emerging market bonds, the investors have the choice of investing in sovereign bond funds or corporate debt funds and also similarly they can choose between US dollar denominated bond funds or local currency denominated bond funds or between broader emerging market funds or funds that target a specific region, country or a group of countries.

While many of the emerging market currencies may offer attractive appreciation potential, they are much more volatile than US dollar. For investors who do not want to take currency risk,US dollar denominated bond ETFs are the best choice. (Read: iShares Launches Emerging Market Corporate Bond ETF)

Below we have analyzed top two ETFs that hold US dollar denominated bonds issued by emerging market sovereigns or quasi sovereign entities. (Read: Van Eck Launches International High Yield Bond ETF )

 J.P. Morgan USD Emerging Markets Bond Fund (EMB - ETF report)

EMB is based on the JP Morgan EMBI Global Core Index that tracks the total return of actively traded debt instruments in emerging market countries. The index includes both fixed and floating rate instruments issued by sovereign and quasi-sovereign entities (100% owned by the government or having 100% government guarantee). The instruments should be denominated in US Dollars and should have a current face amount outstanding of more than $ 1 billion.

EMB currently owns debt from 39 countries with weightings determined by market value. Top country allocations are to Brazil, Russia, Mexico, Turkey, Philippines, Indonesia, Colombia, Venezuela, Peru and Poland. The index is rebalanced monthly.  About 30% of the holdings are rated “BBB” by S&P, while about 14% are rated “BBB-“.

With average bid-ask ratio of 0.03% and average volume (1 month) of about 600 thousand shares, the ETF has a very low trading cost. The fund has returned 8.26% since inception (as of 3/31/2011).

PowerShares Emerging Markets Sovereign Debt Portfolio (PCY - ETF report)

PCY is based on the DB Emerging Market USD Liquid Balanced Index, which tracks the potential returns of a theoretical portfolio of liquid emerging markets U.S. dollar-denominated government bonds issued by 22 emerging-market countries. 

The Fund is rebalanced and reconstituted quarterly. In terms of country allocations, top exposures are to Pakistan, Peru, Qatar, Lithuania, Colombia, Turkey, Uruguay, Panama, South Korea and Vietnam. The fund has returned 8.36% since inception. 43.5% of the fund holdings are rated “BBB” by S&P while 30.3% are rated “BB”.

The fund has an average bid-ask ratio of 0.05% and average volume (1 month) of more than 500 thousand shares. 

 

EMB

PCY

Date of Inception

12/17/07

10/11/2007

Net assets (billion)

$4.73

$1.79

Number of Holdings

124

64

Weighted Average Maturity (years)

12.02

14.86

Effective Duration (years)

7.40

8.89

Expense Ratio

0.60%

0.50%

30-day SEC Yield

4.33%

5.17%

YTD Return

2.11%

3.82%

Though both the ETFs were launched around the same time, EMB has proved to be much more popular than PCY and has attracted $4.73 billion in assets so far, compared with $1.79 billion for PCY. With exposure to more countries and by holding more securities, it is much more diversified than PCY.

At the same time EMB is more expensive, charging 60 bps annually versus 50 bps for PCY.  With a higher duration, PCY is more exposed to interest rate risk and as a compensation for additional risk, it is currently offering 84 bps additional yield over EMB.

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