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ETF News And Commentary

Emerging markets debt ETFs have been in focus of late, due to their solid yields and attractive capital appreciation potential. As a result of investor interest, this space has seen increasing inflows and new product launches recently.

Yesterday, Invesco PowerShares expanded its fixed-income lineup with the launch of the PowerShares Fundamental Emerging Markets Local Debt Portfolio (PFEM - ETF report) on the NYSE Arca.

Investment Case for Emerging Markets Debt

Many emerging countries currently have better fiscal health and lower debt levels than their developed counterparts. Healthy emerging economies also have adequate levels of foreign exchange reserves and deep and liquid financial markets. Credit quality and liquidity in emerging market debt have been improving over the past few years.

Further, yield levels are still quite attractive in emerging countries and many central banks have the flexibility to cut interest rates further to stimulate growth, which would result in price appreciation of debt instruments of these countries. (Read: Buy these ETFs to profit from Japan’s massive easing)

PowerShares Fundamental Emerging Markets Local Debt Portfolio (PFEM - ETF report) in Focus

PFEM seeks to provide investors fundamentals-weighted exposure to emerging market sovereign debt denominated in local currencies. It is based on the Citi RAFI Bonds Sovereign Emerging Markets Extended Local Currency Index, which measures the potential return of a portfolio of bonds issued by the governments of 18 emerging market countries in their respective local currencies.

The Fund has an expense ratio of 0.50% and is expected to issue monthly distributions. (Read: Buy these ETFs to profit from the Great Duration Rotation)

To qualify for the Index, countries must have at least a minimum domestic sovereign debt rating of "CC" by S&P and "Ca" by Moody's.  The Fund and the Index are rebalanced quarterly.

As of May 8, 2013, the fund had 38 holdings with top country allocations to Russia (12.7%), Brazil (11.3%) and Indonesia (9.4%). The product has an effective duration of 5.6 years and a weighted average coupon of 6.6% currently. (Read: Can Anything Stop these Soaring SE Asia ETFs)

ETF Competition

Compared to traditional bond indexes that are generally market-cap weighted, the fundamental index that this ETF tracks, weights bonds based on each country’s economic fundamentals. According to Research Affiliates (index creator) market cap weighted approach can result in greater weights being assigned to issuers that have issued more debt but weighting by fundamentals gives higher portfolio weights to issuers with lower leverage and better debt service capacity, resulting in generally lower credit risk compared to the cap-weight benchmark.

The new product will compete with among others, the two very popular EM local debt ETFs—WisdomTree Emerging Markets Local Debt Fund (ELD - ETF report) and Market Vectors Emerging Markets Local Currency Bond ETF (EMLC - ETF report). These funds already have more than $2 billion and $1.5 billion respectively in assets.

Further, investors who prefer to avoid the volatility associated with emerging markets currencies, prefer US dollar denominated EM debt ETFs like JP Morgan USD Emerging Markets Bond Fund (EMB)  or the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY - ETF report).

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