One Year In, ELD And EMLC Still All The Rage

It’s too soon to write obituaries on early emerging market sovereign debt ETFs such as the iShares JPMorgan USD Emerging Markets Bond Fund (NYSEArca:EMB), but the popularity of newer developing-market debt funds denominated in local currencies makes it seem like the writing may be on the wall.

Indeed, while dollar-denominated funds like the $3.32 billion EMB or the $1.2 billion Powershares Emerging Markets Sovereign Debt Portfolio (NYSEArca:PCY) still rule the roost in terms of asset under management, the shape of a new future may well be coming into focus with each passing day.

The Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca:EMLC) and -- even more so -- the WisdomTree Emerging Markets Local Debt Fund (NYSEArca:ELD), are the poster children for this new investment trend. The Van Eck fund has gathered more than $500 million in just over a year while WisdomTree’s ELD pulled in more than $1 billion over roughly the same period.

Gone, apparently, are the days of Brady Bonds, when investors needed assurance that the sovereign credits they owned in the emerging markets had to be anchored by a credible currency such as the dollar. Indeed, the tables seem to have turned, with analysts raving about government balance sheets in the developing world while growing increasingly alarmed at the indebtedness of the developed world.

“Those who don’t want to play the euro—and may not want to play the developed markets—go into these emerging markets with some acumen about the local markets themselves, and obviously they’ve done really well,” Paul Weisbruch, an ETF trader at King of Prussia, Pa.-based Street One Financial, said in a telephone interview

The Trend Is Your Friend

The eurozone’s debt issues, playing out most prominently around Greece, have haunted financial markets for more than 18 months. And, more to the point regarding U.S.-listed emerging market debt funds, the dollar is in a decade-long secular decline that’s showing no signs of reversing, particularly as the borrowing binge fueling Washington’s deficit spending comes under increasing scrutiny.

What that means is that the declining dollar has become has become a boost to the returns of newer funds like ELD and EMLC. A quick look at the funds -- their yields, their annual expense ratios and what they’ve returned, including adjustments for currency effect, over the past year – makes clear why investors have been so attracted to the two local-currency debt ETFs.

  • EMB has an expense ratio of 0.60 percent, a 30-day SEC yield of 4.41 percent and, according to Bloomberg,a total return over the past 12 months of 9.24 percent
  • PCY has an expense ratio of 0.50 percent, a 30-day SEC yield of 5.19 percent and a total return in the past year of 8.29 percent
  • EMLC has a net expense ratio of 0.49 percent, a 30-day SEC yield of 6.13 percent and a total return of 12.57 percent in the past year
  • ELD, costs 0.55 percent, and has a 30-day SEC yield of 4.82 percent and a total return of 12.03 percent since its inception on Aug. 8, 2010.

Where Does The Trend End?

We wrote about the splashy debuts both funds had last summer, but the question now has become whether current macro-trends favoring growth in the emerging markets over regions such as Europe or the U.S. are sustainable. If so, one has to wonder if funds like ELD and EMLC may end up supplanting EMB and PCY, and become the fixed-income equivalents of big emerging market equity funds.

“If you look at the way both products have performed, I think it’s realistic to think that one day both may become the EEMs or VWOs of the emerging markets debt space,” Weisbruch said. “EMLC and ELD are well positioned, and first to market means a lot,” he said.

He was comparing the potential of the two debt funds to the iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM) and the Vanguard MSCI Emerging Markets ETF (NYSEArca:VWO). The two equity products are the biggest developing markets exchange-traded funds in the world, with assets of about $49 billion and $38 billion, respectively.

Whether ELD and EMLC ever develop that cache, the reality for the moment is that the growing popularity of the newer non-dollar debt funds has added rising prices to a returns mix that already included attractive coupons and the appreciation of many currencies against the dollar.

“The last couple of quarters, the returns on these are outsized compared to what you’d expect on a bond fund,” Weisbruch said.



An Intensifying Focus On Asia

While it’s hard to imagine the fixed-income world without dollar-denominated securities like U.S. Treasurys playing a central role, there’s no denying that the concept of diversifying a portfolio to take on exposure to currencies appreciating against the dollar is catching on like wildfire.

Through May of this year, $6.6 billion around the world had flowed into various emerging markets debt funds, $4.1 billion of which was denominated in local currencies, according to Ed Lopez, New York-based Van Eck’s marketing director.

“It’s a different asset class for investors, with a potential for yield and dollar diversification,” Lopez said in a telephone interview, about funds like EMLC.

“For the last few years, currency has been a risk that’s probably been in your favor. But it is a risk, and it’s being offered up as extra yield,” Lopez added, offering an explanation as to why funds like EMLC have higher SEC yields than similar funds such as  EMB.

Judging by recent developments, the search for ETFs that provide currency appreciation seems to be increasingly focused on Asia, a region of the world chock full of countries with relatively vibrant export-driven economies.

The rollout of the WisdomTree Asia Local Debt Fund (NYSEArca:ALD) has been every bit as splashy as ELD’s introduction a year ago. The ETF came to market in March and already has more than $500 million in assets. ALD, like ELD, has an expense ratio of 0.55 percent, but its 30-day SEC yield is just 2.5 percent, compared to 4.58 percent for ELD and 6.13 percent for EMLC.

Interestingly, Malaysia and Indonesia are the No. 2 and No. 3 holdings in the broad-based ELD, but are No. 5 and No. 7 in Van Eck’s EMLC. That suggests that the portfolio managers behind ELD, an actively managed fund, already considered Asia a cut above other regions well before ALD’s launch this year.

Within the Asia theme, the next frontier in the realm of locally denominated debt funds is clearly China, as a wave of recent regulatory filings by a host of ETF sponsors – including Van Eck and WisdomTree -- clearly indicates.

“Regarding China, there’s great anticipation in the marketplace that the Chinese currency will appreciate,” Van Eck’s Lopez said. “In Asia the yields aren’t necessarily that high, so it’s more of a currency play.”


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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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