In recent days, emerging markets have garnered a major position in the global fixed income investment space. Low interest rates in the U.S., rising commodity prices and ongoing expectations of improving growth in developing economies have made emerging market bond ETFs attractive to investors. Though emerging markets are traditionally associated with greater risks, many developing economies have resorted to sound financial management and have achieved investment-grade debt ratings.
Low Interest Rate in Developed Economies
Globally, interest rates are at low levels, especially in the developed world. Several central banks including the Euro Zone and Japan are practicing negative interest rates in order to boost growth and mitigate deflationary threats.
Though the Fed is on the policy tightening mode, the rise in yields would likely be the highest in the short part of the yield curve, when the step will actually be taken this year. Benchmark 10-year U.S. Treasury yield will likely be less hurt. Investors should note that even after heightened talks about a sooner-than-expected Fed rate hike, the yield on the 10-year U.S. Treasury note was still low at 1.57% as on August 29.
All in all, such low interest rates worldwide should push global investors toward EM ETFs (for higher yield) this time, unlike what we saw amid the taper tantrum in 2013, when the benchmark U.S. Treasury yield crossed 3% (read: Time for These EM Dividend ETFs?).
According to IMF data, emerging market & developing economies grew at 4% in 2015 and are expected to expand 4.1% in 2016 and 4.6% in 2017. These are higher than the global growth of 3.1% seen in 2015 as well as 3.1% and 3.7% expected for this year and the next, respectively. In comparison, the U.S. economy expanded 2.4% in 2015, will likely grow 2.2% this year and 2.5% in 2017 while the Euro zone’s growth rate was 1.7% in 2015. The common currency bloc will likely slow down to 1.6% this year and 1.4% in 2017.
Economic growth is expected to rise in several emerging markets, supported by an easy monetary policy adopted by the central banks with many emerging market central banks cutting interest rates amid lower inflation. Emerging markets debt-to-GDP ratios remain well below that of developed markets. At present, emerging markets are well positioned to attract global investors’ attention by offering high yields with strong macroeconomic fundamentals.
Escalating Capital Inflow
Emerging markets offer lucrative gains to investors willing to take risks. The MSCI Emerging Markets Index was up 9.9% in the last six month. According to Morningstar, $17.1 billion have inflow into emerging markets debt funds (either ETFs or MFs) year-to-date. The emerging markets PMI data at 51.7 for July is also a significant improvement. After April 2013, this is the first time that the figure compared favorably with the PMI data for developed countries. The composite PMI for the four major emerging economies, Brazil, Russia, India and China, was 53.5 in July, indicating the highest expansion since the beginning of 2013.
Rising Commodity Prices
Several emerging markets with significant commodity exposure have been benefiting from rising commodity prices supported by easy monetary policies, surge in demand and a reduction in supply glut. Most of the emerging markets are commodity-centric. While the commodity market has seen enough of bear days, 2016 has turned a new leaf for it. (read: Commodities Enter Bull Market: 6 ETF Winners). Stabilization of commodity prices has helped reignite investors faith in emerging market bonds with the improvement in the economic conditions in these countries.
To boost growth, several emerging economies have been resorting to policy easing via interest rate cuts or offering some accommodative measures. Among the set, China, India, Turkey, Russia and Indonesia deserve a mention. Many of the emerging economies are enacting pro-growth reforms now. So, higher growth rates should offer investors both capital gains and solid yields.
Importantly, emerging market bond ETFs provide portfolio diversification, because their returns are not closely correlated to traditional asset classes. Investors who are looking to offset the currency risk are likely to consider emerging market bonds issued in local currencies as a valuable hedging tool.
ETFs in Focus
Below we highlight a few local currency dominated emerging markets bond ETFs that have performed well year-to-date (as of September 14, 2016).
VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC - Free Report) : This ETF replicates the price and yield performance of JP MORGAN GBI-EMG CORE INDEX. The fund manages an asset size of nearly $2,104.1 million and an average daily trading volume of 1,009,103 shares. The fund charges an expense ratio of 47 basis points a year. The fund is up 13.9% so far this year (as of September 14, 2016).
SPDR Barclays Emerging Markets Local Bond ETF (EBND - Free Report) : This fund seeks to provide investment results that correspond generally to the price and yield performance of the Barclays EM Local Currency Government Diversified Index. The fund manages assets worth $207.1 million and an average daily trading volume of 109,562 shares. The fund charges an expense ratio of 50 basis points a year. EBND has rallied 13.5% so far in 2016 (as of September 14, 2016).
First Trust Emerging Markets Local Currency Bond ETF (FEMB - Free Report) : This ETF seeks maximum total return and current income by investing at least 80% of its net assets in bonds, notes, bills, certificates of deposit, time deposits, commercial paper and loans issued by issuers in emerging market countries that are denominated in the local currency of the issuer. The fund manages an asset size valued nearly $10.8 million and an average daily trading volume of 3,246 shares. The fund charges an expense ratio of 85 basis points a year. The fund is up 13.1% so far this year (as of September 14, 2016).
Wisdom Tree Emerging Markets Local Debt Fund (ELD - Free Report) : This fund seeks a high level of total return consisting of both income & capital appreciation. It invests in bonds in emerging markets. The fund manages an asset size of almost $316.3 million and an average daily trading volume of 117,853 shares. The fund charges an expense ratio of 55 basis points a year. The fund is up 13% so far this year (as of September 14, 2016).
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