It's Not All About Yield For EM Bond Investors

Put simply, a big reason why investors are flocking to emerging markets bond exchange-traded funds this year is yield. Just look at the iShares JPMorgan USD Emer Mkt Bnd Fd ETF EMB and the PowerShares Emerging Markets Sovereign Debt Portfolio PCY.

The two largest emerging markets bond ETFs, both which hold dollar denominated debt, have an average 30-day SEC yield of more than 4.5 percent. That is roughly triple the current yield on 10-year U.S. Treasurys.

Yearning For Yield, But...

Yield is important, particularly with bond ETFs and in the case of emerging markets bond funds, investors usually find tempting yields due to the conventional wisdom that debt courtesy of a developing world government is riskier than a developed market equivalent. Still, liquidity is an important concern in the bond market and recent data suggest investors lean toward emerging markets bond ETFs they view as sufficiently liquid.

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“In the ever evolving trade-off between yield and liquidity however, it seems that investors riding the emerging market bond ETF wave have chosen the latter. This preference for the liquidity is evidenced by the fact that products that investing relatively lower yielding hard currency denominated bonds, such as US dollars, but which carry much less currency risk and liquidity constraints, have seen a 70 percent share of the record $10.3bn that has been invested into the asset class,” said Markit in a recent note. 

The Role Of Liquidity

It is not surprising that investors that prize liquidity would lean toward dollar-denominated ETFs like EMB and PCY. However, the Market Vectors Emerging Mkts Local ETF EMLC, one of the largest ETFs holding emerging markets debt denominated in local currencies, is no slouch. EMLC has added over $611 million in new assets this year, or about 20 percent of the total investors have allocated to emerging markets bond funds denominated in local currencies.

As Markit, the trade-off for liquidity means leaving some yield on the table.

“Local currency funds have also proved popular. However, the fact that over two thirds of investors are willing to pass up on the 1.43% of extra yield currently offered by the asset class, as gauged by the current difference in weighted average yield to maturity between the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) and the VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC), the largest US listed hard and local currency funds respectively, shows that yield isn’t everything,” said the research firm.