Institutional Investors Return To Emerging Markets Bonds

by: Tom Lydon


Emerging market bond ETFs attracting greater attention.

USD-denominated emerging market bond ETFs.

Local-currency emerging market bond ETFs.

By Todd Shriber & Tom Lydon

Exchange traded funds holding emerging markets debt have been among this year's more impressive asset classes.

That after a year in which dollar-denominated funds such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEARCA:EMB) to local currency fare such as the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEARCA:EMLC) were decked by outflows and downturns amid tapering fears.

This year, emerging markets bond ETFs have survived sovereign ratings downgrades in Brazil and Russia, fears of a shadow banking meltdown in China and other adverse headlines to generate decent returns. It appears institutional investors are taking notice.

As retail investors have continued reducing exposure to emerging markets bond funds, institutional investors are wading back in, notes Market Vectors Portfolio Managed Fran Rodilosso:

Poor relative performance last spring and summer as interest rate volatility increased, and the headline risks around the Chinese economy, the Russia/Ukraine situation, Venezuela, Turkey, and a host of other situations are likely, in my opinion, to have caused many retail investors to approach emerging market debt with renewed caution.

Last month, EMB and the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEARCA:PCY), another dollar-denominated ETF, saw combined inflows of more than $650 million.

Although flows data show reluctance on the part of investors to embrace local currency emerging markets bond ETFs, the performance of these funds has been sound. For example, EMLC has surged 6% over the past 90 days.

EMLC recent sturdiness is made all the more impressive when considering the ETF allocates a combined 17.5% of its weight to Brazilian and Russian debt. Both countries were recently downgrade to BBB-, the lowest investment grade, by Standard & Poor's. EMLC also has a 6.6% weight to Thailand, home to ongoing political volatility.

Rodilosso noted that there is evidence that some institutional asset managers, including asset allocation strategists, pension funds, and foreign fund managers, are now increasing exposure to emerging markets in various ways, according to the statement:

Remember that the investable debt universe in EM is largely investment grade. And many of the troubled markets have suffered in price terms. However, at the end of the day, it's up to the investors and their advisors to judge if they are compensated for the risks they are taking.

Investors appear comfortable taking on emerging markets credit risk, at least in the case of the dollar-denominated Market Vectors Emerging Markets High Yield Bond ETF (NYSEARCA:HYEM). HYEM has pulled in $112.2 million in new assets this year, or nearly a third of its current assets under management tally.

HYEM features a 6.71% 30-day SEC yield with a modified adjusted duration of 4.41 years, according to Market Vectors. The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) has a 30-day SEC yield of 4.39% and an effective duration of 3.95 years.

China is HYEM's largest country weight at 11.8% with Brazil, Venezuela and Mexico combining for another 22.3%. HYEM's yield to worst is 7.1%.

Market Vectors Emerging Markets High Yield Bond ETF

Tom Lydon's clients own shares of HYG and EMB.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.