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  • Emerging Markets Bonds

    ETFs Taking Share in Emerging Markets Debt

    Fran Rodilosso ,CFA, Head of Fixed Income ETF Portfolio Management
    November 20, 2017
     

    October marked the ten year anniversary of the first emerging markets bond ETF. The first ETF providing access to emerging markets local currency sovereign bonds, the VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (NYSE Arca: EMLC), launched three years later. Since the launch of that first fund, ETFs have proven themselves to be a reliable and valuable way to access this market.

    Despite the relatively recent explosive growth of ETFs in general, these vehicles still make up only a small part of the overall emerging markets debt market. According to Morningstar, there is approximately $500 billion in emerging markets debt managed assets globally.1 ETFs comprise less than 10% of this total and a similar proportion of such assets managed in the U.S. However, investor flows tell a different story. Year-to-date through October, ETFs garnered 23% of net inflows into the asset class globally and 49% in the U.S. Additionally, over the past four years, while other vehicles have experienced outflows, flows into ETFs have been positive.

    Steady Flows into Emerging Markets Debt ETFs1
    As of 9/30/2017

    Steady Flows into Emerging Markets Debt ETFs Chart

    Source: Morningstar. Past performance is not indicative of future results. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue.

    What is behind this increasing interest? It certainly helps that emerging markets bond ETFs have withstood several periods of high volatility since coming onto the scene a decade ago. These have included the financial crisis, taper tantrum, Brexit, and, more recently, the 2016 U.S. election. During this time, emerging markets bond ETFs have handled large inflows as well as outflows. For example, in 2013 nearly $3 billion exited U.S. emerging markets bonds ETFs. This accounted for approximately 30% of average assets under management (AUM) that year. In the first half of this year, $6.5 billion flowed into the space in the U.S., representing 34% of average AUM.1

    Despite the questions that have been raised about the liquidity of these products (and bond ETFs in general), secondary market liquidity has held up through these various events. Ultimately, the underlying bonds drive liquidity and ETFs are no different from either mutual funds or separate accounts in this respect. However, ETFs provide an additional layer of secondary market liquidity, particularly for larger and heavily traded funds, potentially resulting in lower trading costs for investors.

    EMLC: Secondary Market Liquidity Has Increased
    As of 10/31/2017

    EMLC: Secondary Market Liquidity Has Increased Chart

    Source: NYSE Arca. Past performance is not indicative of future results. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue.

    There are other reasons why we believe that ETFs are particularly well suited for emerging markets debt investors. Emerging markets debt has gained greater acceptance over the past decade as a standalone asset class, separate from a global bond allocation, among asset allocators. For this group of investors, ETFs provide low cost, transparent, and liquid beta exposure. Although ETFs are increasingly being used as part of a strategic asset allocation, perhaps as a complement to actively managed strategies, they are also used tactically by investors. The ability to efficiently add or reduce exposure is especially valuable given the inherent volatility in emerging markets.