As the U.S. continues to teeter on the so-called “fiscal cliff,” emerging market (EM) fixed income investors may be concerned about what this will mean for their bond holdings. Should the U.S. fail to resolve its budget issues, the impact of the impasse will certainly be felt, but may not be as severe as some expect, according to Fran Rodilosso, fixed income portfolio manager at Market Vectors ETFs.
“EM local currency bonds are becoming more strategic, as opposed to purely tactical, allocation for many investors. We believe the market is supported by, in addition to the underlying fundamentals, improved liquidity, expanded yield curves, and a greater opportunity to diversify,” says Rodilosso. “In other words, the money that has flowed in this year might not be as ‘hot’ as in previous years.”
Rodilosso cautions that while the situation has improved, not all the “hot money” has vanished from the market. “We witnessed underperformance on EM local debt in 2011, due in part to outflows on a flight-to-quality trade, so that type of hot money is indeed still there,” he says. “But the progression towards more permanent allocations and, ultimately, lower volatility still appear to be in place.”
Should the U.S. fiscal cliff talks fail, Rodilosso expects that the initial reaction of emerging market local currency bonds will be negative, as investors pull back from “risky” assets. More broadly, a significant drop in U.S. growth would likely dent most EM country fundamentals, as well. At the same time, however, the relative strength of the emerging economies and the relative health of their balance sheets should remain intact as the year draws to a close.
“Looking past the current drama with the fiscal cliff, we see the appetite among institutional investors growing for EM local currency bonds in general, with many looking for a diversified basket of securities,” says Rodilosso. “Lately, we are also seeing more interest in the ‘dim sum’ bond market – where investors can gain more yuan exposure, typically through investments in investment grade corporate borrowers from within and without China,” the Market Vectors fixed income portfolio manager added.
“In the first three quarters of 2012, we saw waning interest in this asset class, but companies are still looking to issue in the yuan market, even at higher rates. The consensus seems to be forming that further yuan appreciation over the medium term can amplify higher rates that most of these entities will pay via U.S. dollar- or Euro-denominated issues.”
Mr. Rodilosso has 20 years of experience trading and managing risk in fixed income investment strategies, including 17 years covering emerging markets. Among the Market Vectors ETFs under his watch are LatAm Aggregate Bond ETF (NYSE Arca: BONO), Emerging Markets Local Currency Bond ETF (NYSE Arca: EMLC), Emerging Markets High Yield Bond ETF (NYSE Arca: HYEM), International High Yield Bond ETF (NYSE Arca: IHY), Renminbi Bond ETF (NYSE Arca: CHLC), Fallen Angel High Yield Bond ETF (NYSE Arca: ANGL) and Investment Grade Floating Rate ETF (NYSE Arca: FLTR). As of November 30, 2012, the total assets for these ETFs amounted to approximately $1.4 billion.
Van Eck Associates Corporation does not provide tax, legal or accounting advice. Investors should discuss their individual circumstances with appropriate professionals before making any decisions.
Please note that the information herein represents the opinion of the author and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
About Market Vectors ETFs
Market Vectors exchange-traded products have been offered since 2006 and span many asset classes, including equities, fixed income (municipal and international bonds) and currency markets. The Market Vectors family totals $27.9 billion in assets under management, making it the fifth largest ETP family in the U.S. and eighth largest worldwide as of September 30, 2012.
Market Vectors ETFs are sponsored by Van Eck Global. Founded in 1955, Van Eck Global was among the first U.S. money managers helping investors achieve greater diversification through global investing. Today, the firm continues this tradition by offering innovative, actively managed investment choices in hard assets, emerging markets, precious metals including gold, and other alternative asset classes. Van Eck Global has offices around the world and manages approximately $37.8 billion in investor assets as of September 30, 2012.
There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. Debt securities carry interest rate and credit risk. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. Credit risk is the risk of loss on an investment due to the deterioration of an issuer's financial health. The Funds' underlying securities may be subject to call risk, which may result in the Funds having to reinvest the proceeds at lower interest rates, resulting in a decline in the Funds' income.
The Funds, as they invest in high yield securities, may also be subject to a greater risk of loss of income and principal than higher rated securities. Investments in emerging markets securities are subject to elevated risks which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict and social instability. The prices of high yield securities are likely to be more sensitive to adverse economic changes or individual issuer developments than higher rated securities. The secondary market for high yield securities may be less liquid than the market for higher quality securities and, as such, may have an adverse effect of market prices of certain securities. As the Funds may invest in securities denominated in foreign currencies and some of the income received by the Funds will be in foreign currency, changes in currency exchange rates may negatively impact the Funds’ return. Investments in emerging markets securities are subject to elevated risks which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict and social instability. Investors should be willing to accept a high degree of volatility and the potential of significant loss. For a more complete description of these and other risks, please refer to the relevant Fund’s prospectus and summary prospectus. Each Fund may loan its securities, which may subject it to additional credit and counterparty risk.
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Fund shares are not individually redeemable and will be issued and redeemed at their NAV only through certain authorized broker-dealers in large, specified blocks of shares called “creation units” and otherwise can be bought and sold only through exchange trading. Creation units are issued and redeemed principally in kind. Shares may trade at a premium or discount to their NAV in the secondary market.
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