Philippines ETF Soars on First Investment-Grade Rating

Shares of the iShares MSCI Philippines Investable Market Index Fund EPHE are up about 2.4 percent Wednesday and the ETF is flirting with its all-time high after Fitch Ratings became the first major ratings agency to bestow an investment-grade credit rating on the Southeast Asian nation.

Fitch upgraded the Philippines' long-term, foreign currency-denominated debt to BBB- from BB and the long-term local currency-denominated debt to BBB from BBB with stable outlooks on both ratings. Fitch cited the Philippines' strong sovereign external balance and persistent current account surplus, the Associated Press reported.

The move by Fitch is not surprising. Over a year ago, Benzinga reported the Philippines was a credible candidate among developing nations to see an increased credit rating. The country would proceed to shatter estimates by delivering 2012 GDP growth of 6.6 percent.

Last June, Standard & Poor's finally got around to raising the country's long-term foreign currency-denominated debt to BB+ from BB, the highest rating since 2003. The new rating is just one notch below investment grade and it is the same rating S&P has on Indonesia, Southeast Asia's largest economy. The move by S&P followed Moody's Investors Service raising its outlook to positive on the Philippines in May 2012.

Following those moves, it was reported that the Philippines could be debt-free in a few years due to its strong government balance sheet and booming business process outsourcing business.

Due to a workforce that is highly educated and chock full of proficient English speakers relative to other developing economies, the Philippines has surpassed India as the top destination for global call centers. Business process outsourcing could be a $25 billion industry in the Philippines by 2016, bolstering the thesis that the country is not as dependent on exports to China as some believe. In fact, in the first half of last year, China was well behind Japan and the U.S. in terms of top destinations for Philippines exports.

Hot Money? Not Really
As EPHE soared in 2012, a run that made it one of the best-performing emerging markets ETFs, plenty of chatter started that the ETF was becoming a destination for hot money, or speculators that would only stick around for quick profits. Statistics indicate that is not the reality.

While many of the marquee developing nations disappointed investors, either in terms of GDP growth, ETF returns or both, EPHE emerged as a credible and more profitable alternative to the funds tracking the likes of Brazil and India. In July 2012, EPHE had just over $142 million in assets under management, but the number surged to $171.5 million by late November.
Destroying the theory that the ETF is a hot money destination is that it is now home to nearly $398 million in assets. Even without the benefit of the Fitch investment-grade move, EPHE was up 13.4 percent year-to-date heading into the start of trading today. That simply blows away the returns offered by the four major ETFs tracking the BRIC nations as well as diversified emerging markets ETFs such as the Vanguard FTSE Emerging Markets ETF VWO and the iShares MSCI Emerging Markets Index Fund EEM.

Bonds, Too
The investment-grade rating will help lower borrowing costs for the Philippines and likely make the country's sovereign debt more attractive to foreign investors. On the downside, yields on Philippine sovereigns have been tumbling in anticipation of an investment-grade rating and downside from here may be limited.

Investors looking to get some exposure to Philippine bonds can consider some already well-known ETFs. The WisdomTree Emerging Markets Local Debt Fund ELD, the second-largest actively managed ETF, has an almost 3.7 percent weight to the Philippines. The WisdomTree Asia Local Debt Fund ALD, also actively managed, has a 5.7 weight to the country. Both ETFs hold issues denominated in Philippine pesos.

Another local currency offering to consider is the iShares Emerging Markets Local Currency Bond Fund LEMB, which currently has a 4.8 percent weight to the Philippines. Those looking for dollar-denominated debt exposure to the Philippines should consider the PowerShares Emerging Markets Sovereign Debt Portfolio PCY.

PCY allocates almost 4.4 percent of its weight to the Philippines and while that may not sound like much, the largest country weight in that ETF is Sri Lanka at 4.5 percent, so it is fair to say the Philippines does figure prominently in PCY.

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