BlackRock’s New ETF Goes Long on Emerging Market Bonds. Not Everyone Agrees

Weak may be the new strong.

Emerging market bonds are expected to outperform again this year, Michel Aubenas, BlackRock’s chief of EM debt, said in a recent interview. A weaker US dollar is expected to contribute, improving the conditions for investing in emerging market bonds. In April, BlackRock launched a new active fund, the iShares $ EM Bond Active Ucits ETF (ISOV) to capture some of that investor interest. However, yield spreads, or the difference between yields on different debt instruments, are already tight. It’s an interesting corner of the market that some experts believe could benefit investors in the back half of the year.

Chris Getter, emerging markets strategist at the alternative asset manager Simplify, said tight spreads are probably more concentrated at the higher end of the rating spectrum, such as countries in the Middle East like the UAE, Qatar and Kuwait. “If you want to get [higher] yield in EM, you’re starting to reach pretty far down the [credit] quality spectrum,” he added, to countries like Ukraine.

Hit Me Hard and Soft (Currency)

Then, there’s the choice between local debt, which responds to changes in the domestic currency rate, and hard-currency debt, issued in more stable currencies, like dollars or euros. Local debt often carries a higher yield, but it comes at the cost of higher volatility and risk, said Matthew Bartolini, global head of research strategists at State Street. But there are benefits to both forms of debt. “EM debt can be a diversifier more than hard currency debt,” he said, since local bonds can offer exposure across several regions and currencies rather than just the dollar.

Emerging market debt should never occupy more than a “satellite exposure” of 2% to 10%, Bartolini added. The largest ETFs that invest in emerging market debt are:

• The iShares JPMorgan USD Emerging Markets Bond ETF (EMB), which has $14 billion in assets and is up 1.37% this year.
• Vanguard’s Emerging Markets Government Bond ETF, which manages $6 billion and is up 1.23%.
• The VanEck JPMorgan EM Local Currency Bond ETF, which sits at $4 billion in assets and is up 1.27%, according to VettaFi data.

Emerging Allocations: In the long run, EM yields are unlikely to outperform indexes, Getter said. “People continue to like EM. There’s good reasons for that,” he added. “But I think given the starting point of an index yield, which is today somewhere around six and three quarters — I’m not jumping up and down about this.”