iShares, the firm behind the most popular ETF in the Emerging Markets Bonds ETFdb Category, rolled out another similar product to complement EMB on Thursday. The new Emerging Markets Local Currency Bond Fund (LEMB) will offer investors exposure to debt of emerging markets issuers that is denominated in local currencies, such as the South Korean Won, Brazilian Real, Mexican Peso, and Polish Zloty. The existing JP Morgan USD Emerging Markets Bond Fund (EMB), which debuted in late 2007 and has attracted more than $3 billion in assets, holds debt that is issued by entities in emerging markets but denominated in the U.S. dollar [for updates on all new ETF launches, sign up for the free ETFdb newsletter].
Under The Hood
The new LEMB will seek to replicate the Barclays Capital Emerging Markets Broad Local Currency Bond Index, a benchmark that includes about 290 individual bonds and has an effective duration of slightly less than four years. According to the official LEMB fact sheet, the largest country allocations in the underlying index are to South Korea, Brazil, Mexico, and Poland. Much like EMB, LEMB casts a wide net that includes debt from more than a dozen different emerging markets.
Because the debt held by LEMB is denominated in the local currencies, investors in this product will achieve exposure to the exchange rates–essentially dollar diversification. When the greenback declines in value relative to the currencies of component emerging markets, that currency movement should boost the returns of LEMB. When the dollar strengthens, however, the value of LEMB will be adversely impacted. Investors looking to add dollar diversification in the fixed income component of their portfolios can achieve it through LEMB, or through similar products from WisdomTree (ELD) and Van Eck (EMLC).
The difference between debt denominated in U.S. dollars and local currencies can be significant. During the month of September–a hectic stretch that saw investors flock en masse to safe havens–the dollar-denominated EMB lost about 4.8%. ELD, which holds emerging market debt denominated in the local currencies, slumped more than 10% as the flight to quality boosted the value of the U.S. dollar. Of course, EMB and ELD are different in more ways than simply the currency exposure, so the comparison is not quite apples-to-apples. Still, last months performance highlights that the presence of currency exposure can impact the risk / return profile in a meaningful way [see For ETF Investors, The Details Matter].
International Bond ETFs
The launch of LEMB continues a trend in the ETF industry that has brought a number of international debt products to market in recent months. With yields on U.S. debt at record lows and showing no signs of jumping any time soon, many investors have begun to look overseas as a way of both achieving diversification and boosting yield in the fixed income portion of their portfolios. According to the LEMB fact sheet, the underlying index had a weighted average coupon of more than 6% at the end of the third quarter.
Other more targeted international bond funds have begun to pop up as well; WisdomTree’s Asia Local Debt Fund (ALD), which includes both developed and emerging markets, has accumulated more than $400 million in assets. Van Eck debuted a Latin American debt fund (BONO) earlier this year that focuses on bonds from Brazil, Mexico, and others in the region. Also, a trio of China bond ETFs have debuted in recent weeks, offering exposure to the “Dim Sum” debt market in Hong Kong.
iShares had a busy week on the product development front; the market leader in the U.S. ETF industry also rolled out a quartet of “minimum volatility ETFs” that focus on stocks exhibiting low risk relative to the broad market.
[For more on LEMB, see the ETF fact sheet]
Disclosure: Long ELD.