Emerging Market ETFs Among Top Performing Bond ETFs

Some of the best-performing fixed income exchange-traded funds this year are local currency emerging market bond ETFs. These funds, like the First Trust Emerging Markets Local Currency Bond ETF (FEMB) and the WisdomTree Emerging Markets Local Debt Fund (ELD), invest in emerging market debt denominated in local currencies.  

In other words, they hold bonds issued by entities in countries like India, Turkey, South Africa, Indonesia and others, and those bonds are denominated in the local currencies of those countries.  

FEMB and ELD are up 8% and 7%, respectively, on a year-to-date basis.  

Local currency emerging market bond ETFs contrasts with dollar-denominated emerging market bond ETFs, like the iShares JPMorgan USD Emerging Markets Bond ETF (EMB) and the Vanguard Emerging Markets Government Bond ETF (VWOB). The bonds within EMB and VWOB are denominated in dollars rather than local currencies.  

Though seemingly a trivial difference, the currency a bond is denominated in can have a profound impact on investors’ returns.  

Local currency ETFs expose investors to currency risk. When the dollar is rising, that hurts returns; when it’s falling, it boosts returns. 

Additionally, dollar-denominated emerging market bonds have greater credit risk. Because it’s not their native currency, emerging market issuers can’t guarantee they can get their hands on the dollars needed to repay their dollar-denominated debt. A sovereign issuer can often make that same guarantee for a local currency bond. 

But just because a local currency ETF might have lower credit risk than a dollar-denominated bond ETF doesn’t make it a better investment per se. Local currencies in emerging markets can be negatively impacted by high rates of inflation. 

And that’s largely why these ETFs have underperformed their dollar-denominated counterparts over longer time horizons. Over the past 10 years, EMB is up 12%, while FEMB is down by 12%.  

Contact Sumit Roy at [email protected]