Heed Bill Gross’ Warning With These Emerging Market Bond ETFs

by on January 7, 2011 | ETFs Mentioned:

One of the most respected names in world of bond investing is Bill Gross, the manager of the globe’s biggest bond fund at PIMCO.  With assets in the fund approaching a quarter trillion dollars, many investors listen when this bond legend speaks–which is quite often. Recently, Gross released his monthly investment outlook in which he took the time to bash the fiscal policy of the world’s biggest debtor, the United States, and its monthly deficit approaching $150 billion in November of 2010. Gross believes that unless something is done soon, a weaker dollar, higher inflation, and the loss of the AAA-credit rating are all but inevitable for the world’s largest economy.

“The problem is that politicians and citizens alike have no clear vision of the costs of a seemingly perpetual trillion dollar annual deficit,” Gross wrote in a note on Pimco’s website on Thursday. “As long as the stock market pulsates upward and job growth continues, there is an abiding conviction that all is well and that ‘old normal’ norms have returned. Not likely. There will be pain aplenty.” In other words, Gross believes that the recovery is likely to be hollow and that any growth in the market will eventually be canceled out by the nation’s debt crisis, which will have to be dealt with eventually. “The American answer to a bulging waistline is always ‘mañana’” Gross wrote. “Eventually, as reflationary policies take hold, long-term bondholders lose their heads (and a portion of their principal as well), as yields rise to reflect higher future inflation.”

Gross also commented on more pressing concerns for the nation, which he believes will further intensify a debt crisis in the long-term. Gross suggested that Congress act immediately to raise the debt ceiling before it imperils the government’s credit rating and spooks investors away from the nation’s debt. He went on to suggest that the government should also focus in on making the country more competitive for the long-term rather than worrying about stimulus measures that only accelerate demand in the short-term at the expense of future fiscal health. “All investors should fear the consequences of mindless U.S. deficit spending,” wrote Gross, who advocates short-durations for U.S. bonds and foreign currency exposure as well [see Going Beyond EEM: Rounding Out Emerging Markets Exposure With ETFs].

Geographic diversification has long been a staple of equity investing, but more and more investors are not looking to expand their fixed income exposure beyond the U.S. as well. Perhaps Gross’ concern over the fiscal health of the U.S. will inspire more investors to take a closer look at foreign debt as a component of their portfolios. Because choosing a single bond issue is often complicated, costly, and inherently risky, many investors have embraced the inherent diversification offered by the exchange-traded structure. ETFs are potentially advantageous as a vehicle for accessing international debt markets  because the basket approach helps to spread the risk across a number of different debt issues and issuers. For investors who believe that now is the perfect time to make a move to diversify fixed income exposure, we highlight two intriguing ETF choices:

Market Vectors Emerging Markets Local Currency Bond ETF (EMLC)

The first ETF to track the emerging market local currency debt space, EMLC seeks to replicate the J.P. Morgan Government Bond Index Emerging Markets Global Core Index. That a benchmark is designed to track a basket of bonds issued in local currencies by emerging market governments. Currently, five countries make up roughly 10% each of the fund, comprising roughly half of the fund’s total assets: Brazil, Mexico, Poland, South Africa, and Malaysia. The fund offers an attractive 30-Day SEC Yield of close to 5.0%, which in addition to helping investors spread out their currency exposure, is far higher than comparable bonds in the developed world [see Emerging Market ETFs: Seven Factors Every Investor Must Consider].

WisdomTree Emerging Markets Local Debt Fund (ELD)

ELD also represents a compelling choice for achieving exposure to debt of emerging markets issuers. The fund offers exposure to roughly half of the number of securities that the fund from Van Eck does, while offering double digit exposure to bonds from four countries: Brazil, Malaysia, Indonesia, and Mexico. ELD is actively-managed, and offers a weighted average coupon north of 7% [read Emerging Market ETF Boom Continues].

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Disclosure: No positions at time of writing.