A prominent figure in the exchange traded fund (
) world describes a RAFI fundamental index evolution, which will
help achieve greater returns at lower risks. However, there is a
caveat. ETF traders will have to see this slow change over the next
Olivier Ludwig for IndexUniverse
asked Rob Arnott, founder of Research Affiliates and the Father of
Fundamental Indexing, about his thoughts on the future of ETFs.
Arnott sees that indexes in the bond ETF market will start to shift
more toward weighting bonds according to an issuer's capacity to
service debt instead of the current weighting to the size of the
issuer's debt. [
ETFs and Indexing: Beyond Market-Cap Weighting.
Emerging markets account for 37% of global GDP but they only
make up 10% of world sovereign bond debt, says Arnott. RAFI for
bonds shows investors that one is better off weighting according to
capacity to service instead of weighting according to the size of
the debt. The logic behind this is that developed countries are
heavily debt ridden while emerging markets are not, but emerging
markets are unfairly attached with a higher risk premium.
iShares JP Morgan USD Emerging Markets Bond Fund
The top countries are Russia, Brazil, Mexico, Turkey and the
Philippines; yields 4.83%.
PowerShares Emerging Markets Sovereign Debt Portfolio
The top countries include Bulgaria, Uruguay, Russia, Vietnam,
Turkey and Indonesia; yields 5.57%.
WisdomTree Emerging Markets Local Debt (NYSEArca:
: Top countries include Malaysia, Brazil, Mexico, Indonesia,
Thailand and South Africa.
Market Vectors Emerging Market Bond ETF (NYSEArca:
Top countries include Thailand, Poland, Turkey, Hungary and
Malaysia; yields 6.45%.
Arnott also describes a RAFI for sovereign debt, which weights
the country according to the size of the economy, the size of the
country and size of its debt-service capacity. Simple intuition
would dictate that lending to countries with little debt is safe
while those with heavy debt burdens are left with less. [
Sovereign Debt ETFs: A Good Bet After Europe's
SPDR Barclays Capital International Treasury Bond
Yield to maturity is 2.8%; holds Italy (11.3%), Germany (10.2%),
United Kingdom (4.6%), France (4.6%), Spain (4.4%), Netherlands
(4.4%), Greece (4.2%) and Austria (3.6%)
SPDR Barclays Cap Short-Term International Treasury Bond
Yield to maturity is 1.6%; holds Italy (11.1%), Germany (11%),
United Kingdom (4.6%), Spain (4.4%), France (4.2%),
Netherlands (4.2%) and Greece (3.4%)
iShares S&P/Citi Intl Treasury Bond (NYSEArca:
Yield to maturity is 2.8%; holds Italy (8.8%), Germany (8.2%),
France (7.4%), United Kingdom (4.9%), Spain (4.7%), Netherlands
(4.7%) and Austria (4.2%)
iShares S&P/Citi 1-3 Yr International Treasury Bond
Yield to maturity is 2%; holds Germany (10%), Italy (7.5%),
France (6.3%), United Kingdom (4.7%), Netherlands (4.5%), Spain
(4.3%) and Greece (4.3%)
Some worry about the notion that the introduction of bond ETFs
are helping to price bonds, but Arnott believes that the price
discovery mechanism in ETFs help the overall market, along with
providing greater liquidity and allowing more investors to control
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Max Chen contributed to this article.