If there is one thing I've learned about Vanguard as a firm, it's that it doesn't rush into anything. It patiently waits and watches as the investment landscape evolves over time, then releases commonsense options to benefit its loyal following of investors.
As emerging-market bonds have become a more widely held sector within a typical fixed-income portfolio, it's no surprise that investors have been forced to look elsewhere for exposure. However, it looks like those days are over as Vanguard recently announced an index-based emerging market (EM) bond strategy to compete with some of the mature offerings from its largest competitors.
The new funds - which will include an ETF (NASDAQ:VWOB), an investor class (VGOVX), an admiral class (VGAVX), and finally an institutional class (VGIVX) - will seek to track the Barclays USD Emerging Market Government RIC Capped Index, comprised of approximately 560 U.S. dollar-denominated securities issued by government, agency and local EM authorities.
The expense ratio of the new funds will range between 0.30%-0.50% depending on the share class. However, there will be a 0.75% purchase fee on non-ETF transactions to offset the higher cost of purchasing EM bonds. So in short, investors seeking a low cost of entry and ongoing expense should simply wait for the ETF to begin trading - it makes little sense to pay the 0.75% fee when the ETF can be owned for the same ongoing 0.35% fee as the Admiral shares.
Over the past three years, I've become a large proponent of EM bond exposure in a strategic income portfolio for a myriad of reasons. The first being that EM countries typically have much healthier balance sheets in addition to their lower overall indebtedness compared to developed markets. Secondly, you have the opportunity for higher yields and improving credit fundamentals as the governments of these nations continue to develop or stabilize, thereby increasing investor confidence. Finally, there are the longer-term structural benefits of higher birth rates, a larger youth population and the lack of entitlement program commitments made to their citizens.
This begs the question, should an investor integrate this new Vanguard offering into their fixed-income portfolio right out of the gate?
Today, the answer is maybe.
A natural candidate I would select for comparison to the new Vanguard ETF would be the iShares Emerging Markets USD Bond ETF (NYSEARCA:EMB). EMB carries some corporate and quasi-sovereign exposure, but the majority of its holdings are invested in government paper. The iShares fund currently has nearly $6 billion in assets spread across 179 holdings, and carries a higher expense ratio of 0.59%.
However, what I'm more interested in examining are some of the more minute details of the new Vanguard offering, including SEC yield, effective duration, credit quality and (of course) a performance comparison. Unfortunately, many of those details will have to wait until the new Vanguard ETF actually begins trading.
Another consideration I'll offer to those interested in allocating to EM fixed income is the WisdomTree Emerging Markets Corporate Bond ETF (NASDAQ:EMCB). I recently wrote an article detailing some of the benefits of actively managed fixed-income ETFs, and I believe EMCB presents an excellent risk/reward buying opportunity for many of the fundamental reasons I pointed out above.
Manager Western Asset employs a top-down macro analysis, in addition to fundamental credit research, to ensure EMCB's portfolio is well positioned to take advantage of the current environment. Since the portfolio is mainly targeting the corporate sector of the EM debt market, I think there is the added benefit of responsible company management and a capitalistic approach to debt issuance. Furthermore, with a nearly identical expense ratio to the passively managed EMB, I believe the WisdomTree option is a bargain for investors.
No matter how you ultimately gain exposure, investors should keep in mind that all EM bonds are typically more volatile than domestic fixed-income options, so be sure to size an initial allocation to your appropriate risk tolerance. The first step to implementing any new position is using sound risk management practices in conjunction with a well-thought-out portfolio management strategy.
Additional disclosure: Fabian Capital Management, and/or its clients may hold positions in the ETFs or mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.