Gone are the days when emerging bond ETFs required the fund manager's active technique. These markets were believed to highly volatile and crammed with political upheavals. But the latest trading pattern and investors' outlook say a different story.
An article published on Seeking Alpha revealed that the iShares JPMorgan USD Emerging Market Bond ETF (NYSEARCA:EMB) beat its active counterparts by an average 74 basis points over the last five years, according to Morningstar.
As a result, investors gathered happily around the fund and allowed EMB - the largest emerging market debt fund - to double its asset base to over $10 billion in the last one year (read: What Bond ETF Inflows are Saying About Fixed Income Trade).
Bloomberg compares the success of EMB with "the largest actively managed fund in the category, the far more expensive Pictet-Global Emerging Debt fund." Notably, the Pictet fund is a Societe D'investissement A Capital Variable, or SICAV, which is an open-ended investment product that's prevalent in Western Europe and similar to a mutual fund.
Let's take a look what led EMB to outperform all.
Low Expense ratio
BlackRock charges 40 basis points (net) for EMB compared with 143 basis points for Pictet's active fund. Bloomberg went on to point out that the average fee for U.S. mutual funds that track emerging markets is about 90 bps, or double BlackRock's pricing, as per data from the Investment Company Institute and Lipper.
In any case, BlackRock has been pretty proactive lately in slashing expense ratios. It reduced fees for core ETFs, six multifactor ETFs and a short-term bond ETF in recent times (read: BlackRock Slashes Fees, ETF Price War Intensifies).
On the other hand, active funds are always known for high costs. These involve research expenses associated with the manager's due diligence and additional cost in the form of a wide bid/ask spread beyond the expense ratio.
Wind is in Favor of Emerging Market Bonds
EM economies are a lot more protected from Fed tightening shocks this time than they were in 2013, which is remembered for the taper-tantrum. As a result, strong fundamentals have lately called for EM investing. And since fixed-income securities are less risky than equities and offer solid yield, investors are all the more keen on these products.
Since volatility in the EM space has ebbed lately, currency issues have somewhat stabilized, and fundamentals have strengthened, the need for active investing (paying a high cost) is likely to diminish. Moreover, the clip of credit rating downgrades in EMs slowed (as per the source) in the second half of 2016, though worries remain.
Notably, emerging market companies and governments sold $178.5 billion of dollar-denominated debt in Q1, marking the highest quarterly amount ever. EMB has gathered about $2.14 billion in assets so far this year (as of April 17, 2017). EMB, which gives exposure to U.S. dollar-denominated government bonds issued by emerging market countries, yields about 4.70% annually.
Yields Are U.S. Treasury-Beating
The Fed is on the policy tightening mode, thanks to which U.S. Treasury bond yield should rise ahead. But investors should note that EM bond ETFs' yields are generally pretty higher than U.S. Treasury yields in a rising rate environment. Going beyond the U.S., several developed economies are practicing an ultra-low monetary policy, which pushed investors to flock to EM debt ETFs.
ETFs in Focus
Given below are some other EM bond ETFs that could be on investors' radar in the coming days thanks to their low cost and high yields.
VanEck Vectors Emerging Markets Aggregate Bond ETF (NYSEARCA:EMAG)
Net expense ratio - 0.49%; Yield - 4.35%
Vanguard Emerging Markets Government Bond ETF (NASDAQ:VWOB)
Net expense ratio - 0.32%; Yield - 5.02%
PowerShares Emerging Markets Sovereign Debt Portfolio ETF (NYSE:PCY)
Net expense ratio - 0.50%; Yield - 5.47%
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