Why Investor Money Is Flowing to Foreign and Emerging Bond ETFs

It’s easier to tell where markets have been than to tell where they’re going. Similarly, it’s simpler to identify where institutional and individual investor money has been flowing than to identify where it will flow to in the future.

Nevertheless, EPFR Global is a world leader in tracking fund flow and asset allocation data. And last week, some fund types experienced their largest inflows of 2009.

According to EPFR Global, global equity funds fared rather well, raking in $1.74 billion. Commodity funds also picked up a cool $1 billion in new assets. Meanwhile, money market funds experienced inordinately large outflows.

Most noticeably, $2.16 billion went into global bonds, with roughly one-quarter of those dollars streaming into emerging market bonds. What’s more, global bond funds have seen inflows every week since the week of 4/6/09-4/10/09.

It appears that investor willingness to invest in something… anything… may have kicked in about one month after developed world markets bottomed in early March. If some comfort had been established one month after the party officially started, will risk aversion via fund outflows occur one month after a stock pullback begins? And if so, will foreign bonds and emerging bonds be hindered or helped in the process?

While U.S. Treasury bonds are likely beneficiaries of a stock market correction, foreign bond ETFs and emerging bond ETFs may be less fortunate. That’s because equity risk aversion may be accompanied by a strengthening of the U.S. dollar. If that’s the case, foreign bonds could be adversely affected by currency risk.

That said, the U.S. stock market and foreign bonds have a longer-term history as non-correlating assets; foreign bond ETFs and emerging market bond ETFs can still zig, even if stocks zag.

In addition, it is still probable that shorter-term U.S. dollar gains will eventually give way to longer-term weakening. And that’s going to help foreign bond ETFs and emerging market bond ETFs.

Year-to-date, here’s how some of the ”majors” stack up:

Foreign Bond ETFs (YTD Through 9/18/09)
					YTD % Gains
SPDR International Short-Term Treasury (BWZ)					16.4%	**
SPDR International Treasury Bond (BWX)					7.0%
iShares JP Morgan Emerging Market Bond (EMB)					9.2%
SPDR DB Inflation-Protected Bond (WIP)					17.3%
PowerShares Emerging Sovereign Debt (PCY)					29.4%
**1/30/09 Inception – 9/18/09

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Comments

[Battlebots:]

Emerging market bond ETFs (EMB & PCY) only hold USD denominated EM bonds. So, there's no local currency play there. I'd love to see a local currency EM sovereign bond ETF (to capture both the asset class and non-USD exposure), but not aware of anything in the works.

Sep 25 01:49 PM

[TheWiseOne:]

The YTD gain for WIP of 17.3% indicated in the post seems to be substantially higher than the one for EMB and of 9.2%. But it's only at the first glance. Once you model a position acquisition over a certain period of time, let say a month including 2 weeks before Jan.1 and 2 weeks after, the gains for both ETFs turn to be similar close to 18% +/-. The emerging market debts behave like the US and G7 debts exactly with minor variations with the correlation of 1. There is no way to use them to diversify a portfolio of debts. The idea of uncorrelated debt markets is dead and buried along with the death of the Long-Term Capital Management.

Sep 29 04:32 PM

[Allamad:]

Also take a look at some well-managed emerging market foreign bond mutual funds like Fidelity New Markets Income (FNMIX) which is up 42% this year and has a 10-year annual average return of 13%. The manager also has the discretion to buy some emerging market stocks when there beat up to juice the return. That sure beats what equities do and it goes down less than emerging market equities when you get the inevitable fall.

Oct 01 04:00 PM