Emerging markets bonds better than US high yield bonds?

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nobsinvestor
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Emerging markets bonds better than US high yield bonds?

Post by nobsinvestor »

Ok, so I'd like to get a debate/discussion started on this topic.

I just read 5 huge old threads on High Yield or "junk" bonds (namely, US corporate ones).

The main arguments in favor of a HY allocation, as put forth by Rick Ferri and others is that is serves as a unique asset class for even more diversification and might provide lower volatility than stocks, which could be even more useful for someone in the retirement/distribution stage. Fair enough.

But what about Emerging Markets bonds, say using Vanguard's relatively new EM bond index fund?

If the goal is diversification and a unique asset class with lower than equity volatility, perhaps EM bonds are the way to go, seeing as how they not only offer high yields, but also the unique diversification attribute of currency fluctuations and other countries? People often make the argument in stocks that owning US only stocks is a home-bias. Then shouldn't owning US high-yield bonds also be a home-bias?

Of course the problem is that we have even less data than US High Yield Corporate to see how EM bonds behave under various market circumstances. Discuss :D
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Re: Emerging markets bonds better than US high yield bonds?

Post by saltycaper »

I don't find the prospect of currency diversification in emerging markets comforting. A currency-hedged fund like EMB seems more appealing.

Diversification of economic policy and central bank interest rates is really the only thing that interests me when it comes to international bonds in general. I haven't dipped my toe into these waters yet though.

I get the math of reducing overall portfolio volatility to achieve higher returns, but doing so with junk or emerging markets bonds, both highly volatile, seems a strange way to go about it.

Junk and EM bonds are like the soon-to-expire discounted donuts I see in the bakery dept at the grocery store. I'm enticed at first, but when I think about what I'd be eating, I walk away.
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Re: Emerging markets bonds better than US high yield bonds?

Post by lack_ey »

Actually, because of foreign exchange concerns for investors, many of these governments issue bonds denominated in USD, Euros, and other more widely circulated and established currencies.

Vanguard's emerging market bond fund is all USD, for example. No hedging required. Even with the steep-for-Vanguard 34 bp ER, the SEC yield is now 4.89% despite being around 80% investment-grade (Baa and up, nominally, albeit mostly Baa) with an average duration of 6.5 years.

I have no idea about the historical track record here and theory, whether emerging market bond exposure in USD or local currency may be better, whether inclusion vs. going with emerging markets equities and more USD bonds is better, etc. But for what (little?) it's worth, I do recall a certain Burton Malkiel (A Random Walk Down Wall Street, now with newfangled robo-advisor Betterment Wealthfront) being high on emerging markets bonds.

edit: I can't even get the two straight. I think they both use emerging market bonds, though.
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Re: Emerging markets bonds better than US high yield bonds?

Post by lazyday »

If risk to you is "bad returns in bad times" then I think US$ EM bonds are a horrible choice.
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Re: Emerging markets bonds better than US high yield bonds?

Post by nisiprius »

"Fortunately" for those advocating emerging markets bonds, 1998 was more than ten years ago and thus doesn't show up in the 1-3-5-10 year returns or the usual growth charts.

Blue line: Emerging markets bonds as represented by the Fidelity New Markets Income Fund. ("Normally investing primarily in debt securities of issues in emerging markets.")

Orange line: Vanguard High-Yield Corporate Bond Fund.

I will leave it as an exercise for the reader to come up with a list of reasons why this doesn't matter. It's not as if it's ever likely happen again; who would ever expect any problems from Russia? :D

Source: Morningstar

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Re: Emerging markets bonds better than US high yield bonds?

Post by nisiprius »

P.S. The bottom line for me is that investment-grade bonds have low risk due to their intrinsic nature. Their risk characteristics, such as they are, can be counted on... more or less.

Once you start throwing in bonds with credit risk--so-called "high yield" (better called "low-grade") bonds or emerging markets bonds or all sorts of risky bonds, who knows what you have? You have something that is neither fish, flesh, fowl, nor good red herring. The burden of proof is on those who claim that it is somehow better to use stock-like bonds than simply to increase stock allocation. It is a fairly heavy burden.

Yes, I know the "diversification" argument but a) correlations aren't reliable, and b) it works both ways. In 1998,
Emerging markets bonds dropped 40%
Stocks dropped less than 20%

That, of course, is "diversification." If that's what you want.

"Diversification" advocates like to point out the times when their favorite investment was going up when stocks were going down, but they tend not to point out the times when it was the other way around. The overall benefits of low correlation show up only in very small differences between very long-term averages.
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Re: Emerging markets bonds better than US high yield bonds?

Post by richard »

Efficient market advocates of diversification would point out that if a security was not useful for someone (e.g., the average or representative investor) at its current price, then it's price would drop until its value to a portfolio was high enough that it was worth buying.

The utility of this argument depends on the extent to which markets are efficient and the marginal benefit from the security in question.
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Re: Emerging markets bonds better than US high yield bonds?

Post by nisiprius »

richard wrote:Efficient market advocates of diversification would point out that if a security was not useful for someone (e.g., the average or representative investor) at its current price, then it's price would drop until its value to a portfolio was high enough that it was worth buying.

The utility of this argument depends on the extent to which markets are efficient and the marginal benefit from the security in question.
I'm not sure where you're going with this.

My opinion is that in an efficient market all securities should be equally "good," everything should have about the same risk-adjusted return, and the investor's only job is to tune portfolio risk-and-thus-return to the level that best fits their needs and risk tolerance. The best way to do this job is to choose a small number of best-known and best-knowable asset classes and keep things simple.

My rationale for using the best-known asset classes is that the plainest and most familiar asset classes are the ones that the market has had time enough to understand and price accurately.

In theory, you could be clever and spot some kind of mispricing in a newish asset class, one so newish that you had asymmetrical information and actually knew more about it than the market. I think this really happens, but I think the beneficiaries are usually the people who introduce the asset class to the investing world--the people who create the new products. Like Michael Milken inventing or creating or promoting junk bonds.

Where things get interesting is when you throw in the claim that diversification is a free lunch, and that you can improve the risk-adjusted reward of a portfolio as a whole by selecting low-correlation assets.

My personal belief is that this is actually true of only two asset classes that have decent positive return and "competitive" risk-adjusted return: stocks and bonds. They have low correlation, they have reliably low correlation. All the other stuff, like different choices or flavors of the basic asset classes, have correlations that are not really low and are not reliably low. Or, like some of the alternatives, they combine genuinely low correlation with low return, and contrary to what is sometimes implied, low correlations are only beneficial if the two assets are reasonably similar in risk and return. If there's much difference in return, the benefit of low correlation doesn't even come close to overcoming the drag of low return.

I think any idea that the market makes persistent behavioral errors over the long-term that it cannot overcome and cannot be arbitraged away is goofy. For example, it does not make sense to me that the market would never have noticed and discounted momentum, or that it is powerless to price in a phenomenon familiar under that very name for at least a century, and the subject of a formal peer-reviewed academic paper in 1937.
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Re: Emerging markets bonds better than US high yield bonds?

Post by Valuethinker »

nisiprius wrote:
In theory, you could be clever and spot some kind of mispricing in a newish asset class, one so newish that you had asymmetrical information and actually knew more about it than the market. I think this really happens, but I think the beneficiaries are usually the people who introduce the asset class to the investing world--the people who create the new products. Like Michael Milken inventing or creating or promoting junk bonds.
Certainly that is what finance faculty in business schools teach. Create a new product which has characteristics the markets need and cannot find anywhere else, and you can make money. For example the Credit Default Swap.

(what is less publicly acknowledged, see Frank Partnoy's FIASCO is that many (but not all) of these products rely on:

- the buyer (Robert Citron, Treasurer of Orange County) being dumber than the seller (a group of Wall Street banks)
- tax arbitrage - moving taxable income to lower tax rate jurisdictions or into the hands of those who naturally pay less tax
- ratings and accounts arbitrage - a clear feature of the Enron scandal was a hole in the accounting rules (the REPO105 transactions of Lehmans appear to have served a similar purpose, US accounting was less strict than European on reporting these REPO transactions), the whole CDO mess was partly about the ratings agencies overrating tranches of CDOs



I think any idea that the market makes persistent behavioral errors over the long-term that it cannot overcome and cannot be arbitraged away is goofy. For example, it does not make sense to me that the market would never have noticed and discounted momentum, or that it is powerless to price in a phenomenon familiar under that very name for at least a century, and the subject of a formal peer-reviewed academic paper in 1937.
Actually I think these anomalies can persist. There is a famous paper by Schleifer on how financial bubbles form and self reinforce. Basically you need an arbitrage opportunity which is too big to grasp: the overvaluation during the dot com bubble, or the US housing bubble (Irrational Exuberance is now in its 3rd edition, with a new bubble). The short sellers go broke before the bubble actually bursts. And some markets are inherently hard to short (US housing was one: China is another).

It seems to be inherent in financial market capitalism that you get bubbles and busts. The problem is how firewalled are you from the rest of the economy? The TMT/ dot com bubble caused a mild recession (which was no fun if you lost your job in it). The US housing bubble led to a world financial crisis.

From the point of view of individual investors it is moot:

- you don't have an infinite lifespan so even if there is a value, or momentum, effect, you might not last long enough to exploit it (the same problem as arbitrageurs have betting against bubbles-- all 3 of the gentlement in The Big Short got in serious trouble before their bets against US housing market came good)

- you don't have infinite margin credit (see point above and The Big Short)

- you don't know which of these 'anomalies' is a genuine one, and which is data mining, or which will disappear once enough academic papers are published. Since hedge funds like AQR hire newly minted Phds Finance from the top schools to pursue anomalies, by the time you hear about it it could well be arbitraged away
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Re: Emerging markets bonds better than US high yield bonds?

Post by countmein »

FNMIX vs VWELX...

- identical sharpe ratios
- FNMIX is higher risk, higher return
- FNMIX is somewhat more correlated to global stocks than is VWELX.
- conclusion: FNMIX has higher risk density, VWELX is the better diversifier.
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Re: Emerging markets bonds better than US high yield bonds?

Post by patrick »

nisiprius wrote:"Fortunately" for those advocating emerging markets bonds, 1998 was more than ten years ago and thus doesn't show up in the 1-3-5-10 year returns or the usual growth charts.

Blue line: Emerging markets bonds as represented by the Fidelity New Markets Income Fund. ("Normally investing primarily in debt securities of issues in emerging markets.")

Orange line: Vanguard High-Yield Corporate Bond Fund.

I will leave it as an exercise for the reader to come up with a list of reasons why this doesn't matter. It's not as if it's ever likely happen again; who would ever expect any problems from Russia? :D
To the contrary, going back longer makes things look much better for those advocating emerging markets bonds! Over the past 10 years Fidelity New Markets Income Fund returned a tiny bit less than you could have gotten from Vanguard Total (US) Stock Market Index or Vanguard Emerging Markets Index. Going back 20 years, on the other hand, shows emerging markets bonds as the best performing asset class by far. Source: http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

Image

Emerging markets bonds gave an annualized 12% if you used Fidelity's fund, and even if you made the "wrong" choice to use T. Rowe Price's emerging markets bond fund, you still would have gotten 10.8%! The next best asset class, US stocks, pales in comparison with only 9.6%. US high yield bonds were even farther behind at 7%. Of course, the next 20 years won't necessarily have comparable results.
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Re: Emerging markets bonds better than US high yield bonds?

Post by nisiprius »

I think you got me on that one.

Anyway... it's not a simple story.
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Re: Emerging markets bonds better than US high yield bonds?

Post by robert88 »

richard wrote:Efficient market advocates of diversification would point out that if a security was not useful for someone (e.g., the average or representative investor) at its current price, then it's price would drop until its value to a portfolio was high enough that it was worth buying.

The utility of this argument depends on the extent to which markets are efficient and the marginal benefit from the security in question.
I think there's an argument to be made that even in an efficient market, principal-agent problems will encourage Wall Street to swing for the fences with their clients' money. That's an issue with all highly risky assets and not just EM bonds though.
Last edited by robert88 on Tue Feb 10, 2015 10:40 pm, edited 1 time in total.
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Re: Emerging markets bonds better than US high yield bonds?

Post by robert88 »

I think it's interesting how small this asset class is if Vanguard is representative in their relative fund sizes.

EM bond - $381 million in total fund assets
US high yield - 16.8 billion
TBM - 136.7 billion.

If I wanted to be like the average Vanguard investor, I would put at most ~0.2% of my bonds into this asset class, which at that point why bother?
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Re: Emerging markets bonds better than US high yield bonds?

Post by madbrain »

robert88 wrote:I think it's interesting how small this asset class is if Vanguard is representative in their relative fund sizes.

EM bond - $381 million in total fund assets
US high yield - 16.8 billion
TBM - 136.7 billion.

If I wanted to be like the average Vanguard investor, I would put at most ~0.2% of my bonds into this asset class, which at that point why bother?
The more interesting question however is, what's the share of EM bonds vs global bonds ? I bet that's more than 0.2% .
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Re: Emerging markets bonds better than US high yield bonds?

Post by HurdyGurdy »

nisiprius wrote:I think you got me on that one.
Yeah right... on data starting in 1995!

Some stats:


"Distribution by credit quality†† (% of fund) as of 12/31/2014, Em Mkt Gov Bond Ix Inv
U.S. Government 0.0%
Aaa 0.0%
Aa 10.0%
A 10.3%
Baa 58.6%
< Baa 21.1%
Total 100.0%

And Maturity:

Distribution by effective maturity (% of fund) as of 12/31/2014 Em Mkt Gov Bond Ix Inv
Under 1 Year 1.1%
1 - 3 Years 12.9%
3 - 5 Years 17.6%
5 - 10 Years 40.6%
10 - 20 Years 11.1%
20 - 30 Years 14.5%
Over 30 Years 2.2%

----------
Look at those holdings!

Image

I guess I would have to understand how such index would behave, historically.
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Re: Emerging markets bonds better than US high yield bonds?

Post by lack_ey »

robert88 wrote:I think it's interesting how small this asset class is if Vanguard is representative in their relative fund sizes.

EM bond - $381 million in total fund assets
US high yield - 16.8 billion
TBM - 136.7 billion.

If I wanted to be like the average Vanguard investor, I would put at most ~0.2% of my bonds into this asset class, which at that point why bother?
Interesting but not really fair in the sense that the high yield fund has been around since 1978, while the EM bond fund got started in 2013. I'm not sure if total bond market includes total bond market II (the version used in the target retirement and other fund-of-fund options).
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Re: Emerging markets bonds better than US high yield bonds?

Post by msi »

Neither one has high enough yields right now in 2015 to justify all the risk.
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Re: Emerging markets bonds better than US high yield bonds?

Post by Valuethinker »

HurdyGurdy wrote:
nisiprius wrote:I think you got me on that one.
Yeah right... on data starting in 1995!

Some stats:


"Distribution by credit quality†† (% of fund) as of 12/31/2014, Em Mkt Gov Bond Ix Inv
U.S. Government 0.0%
Aaa 0.0%
Aa 10.0%
A 10.3%
Baa 58.6%
< Baa 21.1%
Total 100.0%

And Maturity:

Distribution by effective maturity (% of fund) as of 12/31/2014 Em Mkt Gov Bond Ix Inv
Under 1 Year 1.1%
1 - 3 Years 12.9%
3 - 5 Years 17.6%
5 - 10 Years 40.6%
10 - 20 Years 11.1%
20 - 30 Years 14.5%
Over 30 Years 2.2%

----------
Look at those holdings!

Image

I guess I would have to understand how such index would behave, historically.
Credit risk and sovereign risk.

What an interesting combination of countries. The formerly bad doing much better (Mexico, Columbia) and the really not happy (Russia). Mind, Russia won't default, I think that's fairly clear.

It's far too racy a mix for me. There is this one off opportunity when emerging market bonds 'emerge': Indonesia, Mexico, Columbia, Israel? But it can also go the other way. And there are the perpetual penalty box countries (Argentina). I think that post 1998 rush to creditworthiness is over-- it was, in retrospect, a uniquely good time for underdeveloped countries to go 'developed'-- China first and foremost, but others. Now? The world is a more difficult place, and trade is likely to grow less rapidly.

I would rather own the equities in EM, because with the volatility you get potential upside (Israel, South Korea, Taiwan). Companies like Vale, Cemex etc. are world leaders in their own right.
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Re: Emerging markets bonds better than US high yield bonds?

Post by Johno »

madbrain wrote:
robert88 wrote:I think it's interesting how small this asset class is if Vanguard is representative in their relative fund sizes.

EM bond - $381 million in total fund assets
US high yield - 16.8 billion
TBM - 136.7 billion.

If I wanted to be like the average Vanguard investor, I would put at most ~0.2% of my bonds into this asset class, which at that point why bother?
The more interesting question however is, what's the share of EM bonds vs global bonds ? I bet that's more than 0.2% .
Vanguard said in a paper on EM bonds in 2013 that the total outstanding (of market not their funds) of EM bonds was $2.6tril. A Nuveen paper from last year quoted the total size of the world bond market as $85tril, so more like 3%.

But anyway, market cap weight is a far more questionable basis to allocate money among bonds than among stocks, and it has limitations even for the latter (constant and often reasonable discussions here about international stock allocations other than market cap weight). First there's much more direct currency risk in all the bonds not denominated in USD*. And even besides that, market cap weighting of bonds means automatically investing more in relatively highly indebted entities. Level of debt isn't the only factor in suitability of a bond investment obviously, the US govt is still a very good credit though more highly indebted than most EM govts. Still the fact that an issuer leverages themselves more heavily (and happens to do so in the bond market rather than eg. bank loan) is not in itself a reason for the investor to buy more debt of that issuer, as any overriding logical principal I can fathom.

The OP question was whether EM bonds were 'better' than US corporate junk bonds. Not 'better', and many on this forum are hostile to US junk to begin with, and as a result haven't actually been addressing the question but expressing the usual opinion against any investment but stocks and high grade bonds (with general view those should be US govt bonds unless tax considerations force it to be highly rated US non-federal govt bonds, muni's). I would simply answer the actual OP question by saying it's reasonable to believe that *if* there's any value to US corp junk in a portfolio, EM bonds probably add diversification. Why wouldn't they? Now, do people strictly *need* complications like lower grade bonds in their portfolios? No, I agree with the simplifiers to that degree: no one will come to ruin specifically by not buying either US junk or EM bonds. I have the former in pretty small allocation (was somewhat larger at one time), latter smaller still, not even 3% of my bonds, mainly for fun, the CEF ticker ESD, fairly large discount, some leverage, USD EM govt and corporate debt, ~8.7% pay out rate currently.

*in contrast people only confuse themselves to assume stocks quoted in currency X are actually nominal assets in currency X: the currency risk of stocks is entirely dependent on the correlation of the assets and liabilities of the company to currency value(s, not just X's) and has nothing directly do with the unit of account in which the stock price is quoted. But nominal bonds in currency X are really literally a promise to pay a given amount of currency X, with the only correlation 'loosening' factors being how the yield correlates to currency X value, and ultimately if held to maturity how the default probability correlates with the value of currency X, reasonably foreseen as most defaults occurring when currency X is very weak. But USD denominated EM bonds are definitely also affected by currency movements, since country or company issuer are generally relying on EM currency revenue to some degree to pay off a USD liability.
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Re: Emerging markets bonds better than US high yield bonds?

Post by Sammy_M »

See below for Research Affiliates' outlook on EM currency vs. EM debt. Appears they expect all the return from the EM debt asset class to come from FX.

Image
http://www.researchaffiliates.com/Asset ... rview.aspx

I wonder if buying Wisdomtree's CEW fund would be a better play than EM debt since it inherently has less default risk, and according to RA, less expected volatility with nearly the same expected return.

RA obviously feels that both EM debt and EM currency are better investments than high-yield US bonds...at this time.
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Re: Emerging markets bonds better than US high yield bonds?

Post by tibbitts »

countmein wrote:FNMIX vs VWELX...

- identical sharpe ratios
- FNMIX is higher risk, higher return
- FNMIX is somewhat more correlated to global stocks than is VWELX.
- conclusion: FNMIX has higher risk density, VWELX is the better diversifier.
Diversifier vs. what?
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Re: Emerging markets bonds better than US high yield bonds?

Post by lazyday »

Sammy_M wrote:Wisdomtree's CEW fund
Oddly, I didn't see a place to download the annual report.

Googling this will return a result from hosted.rightprospectus.com for the Aug 31 2014 report:

Code: Select all

annual-report wisdomtree trust Currency Strategy, Fixed Income and Alternative Funds
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Re: Emerging markets bonds better than US high yield bonds?

Post by Sammy_M »

lazyday wrote:
Sammy_M wrote:Wisdomtree's CEW fund
Oddly, I didn't see a place to download the annual report.

Googling this will return a result from hosted.rightprospectus.com for the Aug 31 2014 report:

Code: Select all

annual-report wisdomtree trust Currency Strategy, Fixed Income and Alternative Funds
Here is a link to all reports on all their funds
http://www.wisdomtree.com/resource-library/

The attribution report is an interesting read too
http://www.wisdomtree.com/resource-libr ... 4-1753.pdf
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Re: Emerging markets bonds better than US high yield bonds?

Post by lazyday »

Sammy,

If you click "currency" on your RA link, you can see expected returns for 12 of the 15 currencies in CAW. Chile, Columbia, Philippines are missing.
You can "Export Data" near the bottom of the page, and sort by "Market".

Since CAW rebalences to equal weight, I averaged the RA 12/31 expected return for the 12 currencies (removing Taiwan). Result is 5.2%. This seems to ignore the expected "credit loss" of .2% but that's probably ok since futures are used--or in case of default do the futures return -100%?

We might hope for an internal rebalancing bonus. We need to remove the ER of .55%, and I don't know if there's hidden costs in the futures contracts.

Hope to read some of the annual report, and revisit the RA currency methodology paper which I've only skimmed in the past. http://www.researchaffiliates.com/Produ ... df?print=1
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Re: Emerging markets bonds better than US high yield bonds?

Post by lazyday »

Didn't spot much that's interesting in the annual report. There is a capital loss carryforward, but it still might be best to hold in an IRA. I don't think there's any foreign taxes involved (assuming it never invests directly), and if I understand correctly, after the fund does well enough, there will be short term gains.

Still haven't seen anything on hidden costs of futures (or swaps, etc, when used). Who's on the other side of the trade and why? International companies, speculators? Hidden costs could be negative, but if there isn't enough demand on the other side of the trade, the fund may have to pay others to give us exposure--and they will have costs, possibly including large foreign tax costs.

WT has an "Equal Weighted Emerging Currency Composite" we can compare to fund performance. http://www.wisdomtree.com/resource-libr ... EW-675.pdf
But the composite just measures performance of the contracts themselves, not exchange rates and local bills. And the fund market price has still trailed it by about 1% since 2009 inception. It appears that ER has been .55% since inception, or shortly after.

Not excited to pay 1% in ER + hidden costs, before any hidden costs of the contracts.

CEW seems to be the only broad EM currency ETF: http://etfdb.com/etfdb-category/currency/

Didn't notice any EM short term bond ETFs worth considering. http://etfdb.com/etfdb-category/emerging-markets-bonds/
http://etfdb.com/etf/SEMF/ is expensive and $2 mil in size.
Last edited by lazyday on Tue Feb 17, 2015 5:07 am, edited 1 time in total.
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Re: Emerging markets bonds better than US high yield bonds?

Post by Sammy_M »

lazyday wrote:Didn't spot much that's interesting in the annual report. There is a capital loss carryforward, but it still might be best to hold in an IRA. I don't think there's any foreign taxes involved (assuming it never invests directly), and if I understand correctly, after the fund does well enough, there will be short term gains.

Still haven't seen anything on hidden costs of futures (or swaps, etc, when used). Who's on the other side of the trade and why? International companies, speculators? Hidden costs could be negative, but if there isn't enough demand on the other side of the trade, the fund may have to pay others to give us exposure--and they will have costs, possibly including large foreign tax costs.

WT has an "Equal Weighted Emerging Currency Composite" we can compare to fund performance. http://www.wisdomtree.com/resource-libr ... EW-675.pdf
But the composite just measures performance of the contracts themselves, not exchange rates and local bills. And the fund market price has still trailed it by about 1% since 2009 inception. It appears that ER has been .55% since inception, or shortly after.

Not excited to pay 1% in ER + hidden costs, before any hidden costs of the contracts.

CEW seems to be the only broad EM currency ETF: http://etfdb.com/etfdb-category/currency/

Didn't notice any EM short term bond ETFs worth considering. http://etfdb.com/etfdb-category/emerging-markets-bonds/
http://etfdb.com/etf/SEMF/ is expensive and $2 mil in size.
Thanks for the analysis, good points. Tough call on whether to live with the tracking error associated with CEW or take on term risk with PFEM, EMLC or EBND. The term risk seems very significant in local denominated EM bonds because of inflation concerns.

SEMF appears mostly USD denominated, and if you believe Research Affiliates analysis is correct, it's local denomination that you want. If going with USD denominated, VWOB seems the best best due to the low expenses.
lazyday
Posts: 3849
Joined: Wed Mar 14, 2007 10:27 pm

Re: Emerging markets bonds better than US high yield bonds?

Post by lazyday »

I didn't notice that SEMF isn't a local currency fund.

I personally wouldn't want EM bonds except maybe short term, unless they offered a huge yield to make up for the risks.

The currency fund seems worth learning about, because of the high yield and chance of PPP reversion, with low credit and term risk compared to bonds. Averaging for the 12 (of 15) currencies: 2.5% real yield + 2.7% FX = 5.2% real.

The yield is a 10 year prediction, using complicated methodology (page 5). I think the predicted yield is lower than current yield today. "FX" valuation change (page 7) including PPP reversion is easier to follow. Credit risk is not shown in the cash methodology, but on the chart you linked it is included in the currency prediction. Would have to find what happens to the futures when there's a default on bills.

CEW could perform poorly for a long time, and I'd want to be able to hold on at low total cost while waiting for reversion. But it's possible that futures will become illiquid, and the fund will need to use more expensive means of exposure. Even with high liquidity, I don't know if hidden costs of using futures might increase over time. I don't even know the current cost.

I don't know why since 2009 the NAV is behind the futures composite by .8% a year, or why the market performance is .2% worse than NAV. .2% seems a lot, as EM currencies are much more stable than EM equity on the timeframe of an FMV calculation.

Momentum is negative, and not included in the RA analysis.

I might revisit the fund and strategy in a year or two, with more data. Especially if momentum becomes flat or positive without much valuation deterioration.

If anyone has answers to above, or info on historical diversification benefit of EM currencies (not bonds) for a portfolio that includes EM equity, I'd like to see it.
HurdyGurdy
Posts: 1177
Joined: Wed May 09, 2012 10:21 pm

Re: Emerging markets bonds better than US high yield bonds?

Post by HurdyGurdy »

Wall Street Journal says "Moody's said it was cutting Petrobras' ratings to Ba2..."

Vanguard Emerging Markets Government Bond Index Fund has many state (or pub/priv) oil company bonds. Buyer beware.

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