Emerging Market Local Debt ETFs Ripen

March 23, 2016

This article is part of a regular series of thought leadership pieces from some of the more influential ETF asset managers in the money management industry. Today's article is by Michael McClary, chief investment officer of Akron, Ohio-based ValMark Advisers, which markets the “TOPS” brand of asset allocation models.

Tiger Woods made a splash in the golf community years ago when he started hitting greenside shots with his 3-wood. When faced with certain green-side shots, using a 3-wood (or hybrid club) in a putting motion can give the ball enough lift to carry longer grass and project it toward the hole.

In the era of space age golf-club design, technology often rivals that used by NASA. Some companies have even collaborated directly with NASA contractors on club design.

With so much work going into designing a 3-wood specifically to provide lift to carry a ball more than 200 yards, why are some golfers using it to hit putterlike shots of five to 20 yards?

The answer is that it might be the optimal club for the shot and may lead to the best overall score.

Prioritizing Risk
We often encounter portfolios that are a collection of underlying positions chosen at face value: utility stocks chosen for income, Treasurys chosen for safety of principal and little attention paid to how these individual decisions might impact overall portfolio metrics. Likewise, we often see investors surprised when a position significantly underperforms their expectations due to a risk they hadn’t prioritized.

We feel investors may benefit from looking at investing in emerging market local debt like chipping with their 3-wood. Pay attention to the full spectrum of attributes in EM debt—not just the obvious—and focus on how it interacts with other positions to impact your overall score.

ETFs Give Investors More Choices
As ETFs have grown in size and number, investors have been given the opportunity to invest in areas of the market they may not have invested in 20 years ago. While many mutual funds have invested in EM debt for many years, it was not until the last six or seven years when investors had the ability to take the reins and easily pinpoint their EM debt exposure.

For example. now, investors can choose from investing in EM local debt: the WisdomTree Emerging Markets Local Debt Fund (ELD | C); dollar-denominated EM debt—the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB | B-58); and EM corporate debt—the WisdomTree Emerging Markets Corporate Bond ETF (EMCB | C).

With so many viable choices, investors have to think about more than just the opportunity for more yield.

Emerging Market Debt’s Upside Surprise

Over the last few years, emerging markets have been drinking a toxic cocktail of currency head winds, slowing growth and crashing oil prices. This is a drink that would knock any market out, but it has had particular negative impact on emerging markets.

Likewise, the doom and gloom has not been limited to equities. Emerging market debt struggled in 2015, falling victim to exchange rates.

The drop in value of EM local debt ETFs in 2015 was directly tied to the loss in EM currencies, as U.S. dollar-denominated EM debt finished relatively flat.

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