With more exchange traded fund options now available, fixed-income investors can expand their portfolios to include emerging market debt exposure. However, not all ETFs are created equal, so potential investors should review the various offerings before diving in.
For starters, some of the first emerging market bond ETFs to hit the market are denominated in U.S. dollars, writes Morningstar analyst Karin Anderson.
“While investors aren’t exposed to the currency risks of the underlying issuers, they are taking on credit risk stemming from political, regulatory, or market developments,” Anderson said.
For example, the iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) tracks U.S dollar-denominated government bonds issued by emerging countries. Investors will be exposed to risks associated with the more volatile emerging markets and lower-rated countries, but the fund does hold investment-grade quality debt as well, including AA 2.8%, A 10.1% and BBB 42.2%.
Investors can also browse through a number of local-currency emerging market bond ETFs, which expose investors to the currencies of the underlying issuers. For instance, the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) tracks a basket of local currency bonds issued by emerging market governments.
Anderson points out that local currency funds “have shorter maturities and shorter durations and are therefore less sensitive to changes in interest rates.” EMB shows an average effective duration of 7.13 years while EMLC has a duration of 4.48 years.