Active Management Comes To Emerging Market Bond ETFs

WisdomTree has introduced a new addition to the ETF landscape with their launch of an active ETF in the emerging market bond category.

Emerging market bonds are a unique asset class with extraordinary characteristics, which many ETF investors have chosen to make a part of their portfolios.  Emerging market bonds have high absolute returns with low correlation to other markets, and are also high yielding vehicles.

Of the products on the market, The WisdomTree fund is the only local currency and actively managed fund.  The passive US Dollar ETFs have been on the market for some time and Van Eck Global launched its Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) recently as the first local currency emerging market bond ETF, which is also a passive product.

Because of these two newer entrants into the emerging market bond space, investors have a lot of choices when including emerging market debt into portfolios.

The WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) is unlike other emerging market bonds in the ETF marketplace to date. Given in its name, the WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) invests in emerging market bonds dominated in their local currency.  This is in contrast to the other bond ETFs in the category on the market.  For example, the iShares JPMorgan USD Emerging Markets Bond Fund (NYSEArca: EMB) is the largest in the category with assets of $1,962,167,846.  EMB is a passively managed index fund.  The index that this fund tracks invests in bonds issued by emerging market governments in US Dollars.  The reason for US Dollar dominated bonds is to add a layer of currency security.  Emerging market currencies tend to be extremely volatile with wide swings down and up.  With US Dollar bonds, the issuing governments bear the risks from the currency volatility.  Long-term currency valuations are, however, reflected in the value of the bonds despite the issuing currency, since currency can express many relative things to an economy-such as a country’s relative strength to the US or Europe.

The WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) affords investors an opportunity to gain access to emerging market bonds issued in local currency and an active edge on the asset class.

“ELD will offer full exposure to local currencies, a feature we consider important for many investors because of the potential lower correlations and currency appreciation against the U.S. Dollar,” said Bruce Lavine, President and CEO of WisdomTree, in a press release.

Currency does have a significant impact on total returns of international investments.  Over the last year, currency has contributed to a 3.80% difference between local currency and US Dollar returns in Emerging Market stocks; the MCSI Emerging Market Index Local Currency returned 13.98% and the MSCI Emerging Market Index USD returned 17.78 over the same time period.  During other time periods, however, this effect has hurt the US investor and can cause a significant difference in returns.

Long-Term Focus in Emerging Markets

In an ETF category with four investment vehicles all offering a small twist on the asset class, it will be a great study on which style of investment works best for emerging market bonds over different market conditions. The WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) is active and will seek to take advantage of inefficiency in the emerging bond markets.  This will be very interesting.  In inefficient markets, bonds can offer many places where a manager can take advantage of including duration, currency, default risks and valuation.

A major concern brought up by many ETF commentators is how passive bond indexes will award issuers who have more debt issues with higher allocations.  In effect, this means that the funds reward debt, allocating more heavily towards more indebted countries and companies.  Active managers should be able to bypass this problem very easily and will therefore lower some of the inherent risks in the bond portfolio.

By Published On: August 19, 2010

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