by Aaron Levitt | December 31, 2013 8:40 am
Even with Fed beginning its much ballyhooed taper, interest rates are still in the basement. And they’re likely to stay relatively low for quite some time. That news has sent investors into all-sorts of different types of bonds and asset classes looking for yield.
Emerging market bonds and debt have become one of the most popular stopping points as investors look to expand their options. That is, unless you’re the Market Vectors Latin American Aggregate Bond ETF (BONO).
Launched back into 2011, BONO — which focused on bonds from Brazil, Peru and other Latin American nations — never really caught on with investors. The exchange-traded fund (ETF) struggled to find its footing, assets and trading volumes since its launch. That prompted Van Eck — the fund’s sponsor — to do a major portfolio makeover.
The switch in underlying assets could make the new BONO — now dubbed the Market Vectors Emerging Market Aggregate Bond ETF (EMAG) — one of the best emerging-market bond ETFs for investors looking to add the asset class.
While BONO never really caught on with investors, its replacement fund could be a huge hit for Van Eck and be a great portfolio construction tool for investors. The key for the new EMAG ETF is its new broader mandate and what it will track.
While BONO just focused on Latin American bonds, EMAG will track emerging market bonds from the entire world. That includes places like Chile, Thailand and Poland. Van Eck decided to self-index the new fund, providing EMAG with a unique portfolio. Overall, EMAG’s underlying index features 1,794 bonds from a total of 694 different issuers. That’s a very broad array of underlying bonds.
However, the story gets even better for investors and EMAG when you take a look at what makes up those nearly 1800 bonds.
Emerging market bonds basically come in two flavors — U.S. dollar denominated and local currency. In the beginning, many emerging market nations first began issuing debt denominated in U.S. dollars. That was done as a hedge as well as to add additionally security to the bond. The general idea was that the greenback would be a reliable protection if an issuing country began to falter. Essentially, the dollar would hold it up.
Over the last decade or so, many emerging market nations have experienced better-than-average financial performance and have finally begun to issue bonds in their local currencies. For some nations, that has actually reduced boring costs and strengthened their positions even further.
Previously, if investors wanted to add emerging market debt to a portfolio, they were forced to choose between the two types. For example, the $4 billion iShares JPMorgan USD Emerging Markets Bond (EMB) holds only U.S. denominated bonds, while the $1.24 billion WisdomTree Emerging Markets Local Debt (ELD) holds only foreign currency-based bonds.
Investors wanting to take advantage of both variety of bonds — to take advantage of currency fluctuations and potentially higher yields –– needed to add both styles of funds and figure out what percentage of each type to hold. This doesn’t even include the divide between corporate and government issuers.
Well, the new EMAG takes care of that guess work for retail investors.
EMAG will provide exposure to all four major categories of EM bonds. That includes both sovereign and corporate bonds issued in both U.S. dollars and local currencies. EMAG also takes its diversification one step further and includes both investment-grade and below-investment-grade rated securities. Typically, investors needed to add a separate emerging market junk bond fund — like the iShares Emerging Markets High Yield Bond (EMHY) — if they wanted high yield exposure as well.
Given that it’s the only broad emerging market debt fund covering all aspects of the sector, EMAG could be the best way to add these bonds to a portfolio. Aside from taking the guess work out of which bonds to hold and in what percentages — a huge win in itself — EMAG also delivers on the cost front as well.
First, even if investors wanted to split 50/50 on their USD and local currency bonds, that requires two funds and double the trading costs. Secondly, despite their sizes, most emerging market debt funds are very expensive on the operating cost front. The previous mentioned EMB and ELD cost 0.60% and 0.55% in expenses, respectively.
Even with its broad holdings, EMAG will cost just 0.49% — or $49 per $10,000 invested to own.
That low expense ratio makes it one of the cheapest options in the sector to own, period. Even then its cheaper rival — the Vanguard Emerging Markets Government Bond ETF (VWOB) — only holds USD government bonds. There’s not any corporate or local currency exposure to be had in VWOB.
With its lower expenses and broad all-encompassing mandate, EMAG offers one of the best one-stop shops for investors looking to emerging market bonds to portfolio.
As of this writing, Aaron Levitt was long EMHY, EMB and its local currency twin — the iShares Emerging Markets Local Currency Bond (LEMB). However, he may switch to EMAG as trading volume picks up steam and assets grow.
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