Inflows into emerging market debt ETFs picked up sharply in July amid global market volatility, after Britain voted to leave the European Union and the US Federal Reserve continued to hold interest rates in its latest monthly meeting.
According to Bloomberg, local currency EMD has returned 4.8% (in US dollar terms) this year to 26 July, while the return on dollar sovereign notes issued by developing countries has jumped to 12%, placing both indices on track for the best returns since 2012.
In comparison, the yields on government debt issued by many developed nations have hit negative territory this year, including Germany, Japan, and even the UK, where gilt yields finally succumbed to pressure following the Brexit vote.
This backdrop, coupled with the prospect of an interest rate hike by the US central bank being pushed back into 2017, is drawing investors to this area of the market in their search for yield.
An interest rate hike, which would boost the US dollar, could be bad news for many emerging market nations, hitting their currencies and commodity prices and increasing borrowing costs, but as the Fed holds off from increasing rates further amid global volatility emerging markets look like an attractive proposition.
Exchange traded funds were the beneficiaries of this pickup in investor sentiment in July, reporting record gains during the weeks following the Brexit vote and the Fed’s latest policy meeting.
Four of the largest ETFs researched by TrackInsight display this trend, raising between one third and two thirds of their total fund assets during July alone.
iShares Emerging Markets Local Government Bond UCITS ETF (denominated in US dollars) saw the largest inflows of the lot, taking in some €534.8m, which accounted for 46% of its total assets. This is substantially larger than any flows the fund has received in the previous months, with €44m going into the product in June and outflows of €106m the previous month (altough April also saw strong inflows).
Investors also favoured iShares J. P. Morgan $ Emerging Markets Bond EUR Hedged (denominated in euros) and iShares J.P. Morgan $ Emerging Markets Bond (in US dollars). These two saw €511.2m and €511.8m coming in, respectively, making up 67% and 36% of the total assets held in each of the funds.
Meanwhile, SPDR’s Barclays Emerging Markets Local Bond product, denominated in US dollars, took in €218m in July, a 33% share of its total assets. All of these figures far exceed any inflows seen into these products since January.
The big questions now are whether these strong flows can continue, and if they do, will local currency debt see the same interest as US dollar denominated bonds? The latter has seen the bulk of inflows in July, but has already rallied strongly this year, but local currency debt remains a higher risk proposition.