Emerging Market Local Debt ETFs Shine

March 23, 2017

Investors Largely Underweight

These funds’ performance stand out relative to the returns seen in the iShares Core U.S. Aggregate Bond ETF (AGG), which is up only 0.7% in the same period, and the iShares 20+ Year Treasury Bond ETF (TLT), up 1.7% to-date in 2017.

To someone like Mark Dow, founder of Dow Global Advisors, that’s no surprise, even if most investors seem to missing out on the move, remaining largely underweight the segment.

Dow, whose experience includes roles as a policymaker, investor and trader focused on global macro and emerging markets, has been making a case for emerging market local currency bond investing for a long time.

And here’s why. According to him, there’s still no significant growth in emerging market economies to speak of; there’s no real earnings power behind the little growth we’ve seen. But emerging markets are in an ongoing bottoming process, and EM currencies seem to have already “bombed out.”

“The great thing about local currency sovereign bonds is that they have a really nice yield,” Dow recently said. “And if you think the currency has taken its biggest hit, it's going to be hard for the currency to depreciate more than the yield you're getting from those bonds.”

With EM local currency sovereign bond ETFs, “you get good yield and you're not taking credit risk,” he said.

Asset Flows Still Lagging

Still, asset inflows into the segment remain small year-to-date. EBND, for example, has seen zero net asset inflows so far in 2017. FEMB and LEMB have seen a combined $13 million in net creations year-to-date, while ELD has attracted $14 million.

The exception here is EMLC, which has seen net inflows of $338 million so far this year, with a lot of those assets coming early in the year. But EMLC is the largest local-currency EM bond ETF, with $2.8 billion in total assets.

It could be that investors are still afraid of what higher rates and a strong dollar could do to emerging markets in general—the same type of concern that has BlackRock neutral on the segment.

However, according to Dow, a clearer view of U.S. rate policy—where it’s headed—is the first step in allowing emerging market fundamentals to improve. And we are getting just that, a clearer picture. A rapid rise in rates would hurt the region, but that doesn’t seem to be what the Federal Reserve has in store.

 

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