Vanguard launches USD emerging markets government bond ETF

Dec 7th, 2016 | By | Category: Fixed Income

Vanguard has expanded its range of European-listed UCITS exchange-traded funds with the launch of the Vanguard USD Emerging Markets Government Bond UCITS ETF (LON: VDET). The fund offers regional exposure to US dollar-denominated debt issued by governments in emerging markets.

Vanguard launches USD emerging markets government bond ETF

The ETF invests in US dollar denominated fixed income securities with maturities greater than one year and which have a minimum issue size of $500m, issued by emerging markets sovereign or ‘quasi-sovereign’ entities.

The fund tracks the Bloomberg Barclays USD Emerging Markets Sovereign and Quasi Sovereign Index through physical replication, meaning it buys and holds physical securities comprising the index, rather than using derivatives to gain its exposure.

The index includes only those bonds with maturities greater than one year and which have a minimum issue size of $500m. Bonds issued by ‘quasi-sovereign’ emerging market issuers – entities that are government guaranteed or are more than 50% owned by governments and local authorities – are also included.

As of 31 October 2016, the index was fairly evenly divided between exposure to sovereign bonds (51.3%) and agency/quasi-sovereign bonds (48.0%). The largest country exposures are currently China (14.2%), Mexico (7.8%), Brazil (6.9%), Russia (6.5%) and Indonesia (5.3%). Approximately 60% of the index is composed of investment grade rated bonds.

Andreas Zingg, Head of ETF Distribution Management, Europe said: “Following the US election and increased speculation on the possibility of a US rate hike, emerging market bonds have been in the headlines. In our view, investors should continue to keep a long-term perspective.

“As part of a balanced portfolio, bonds provide an important source of diversification, helping to stabilise returns over the long term. Investors can maximise this effect by also diversifying within their fixed income allocations.”

As of 30 November 2016 the index is up 8.4% year-to-date and has returned 5.2% per annum over the past three years.

Investors may tend to prefer investing in emerging market bonds that are denominated in major trading currencies (such as the US dollar) for several reasons. Typically these securities are easier to trade than locally denominated bonds thereby lowering bid/ask spreads. Emerging market currencies also typically experience greater volatility compared to major trading currencies. Investors may feel they are being inadequately compensated for accepting the risk that local currencies will depreciate relative to their home currency, thus reducing returns.

Emerging market debt issued in major trading currencies does have its drawbacks however. It becomes more expensive for the issuing government to pay down international debt denominated in a foreign currency if their home currency is depreciating. This may result in the country depleting its foreign reserves and jeopardizing its ability to pay. In the instances of financial crises, the government is limited in its options to repay the debt due to its inability to control the money supply of the bond’s denominated currency.

The ETF has a total expense ratio of 0.25% making it the most competitively priced ETF in its peer group, according to Bloomberg.

It is also available to UK investors in a GBP trading line (LON: VEMT), and through USD or CHF trading lines on Six Swiss Exchange.

There are a number of ETFs listed in Europe providing exposure to US dollar denominated emerging market sovereign bonds. The largest of these is the iShares JP Morgan $ EM Bond UCITS ETF (LON: IEMB) with $5.6bn in assets under management (AUM). The fund invests in US dollar denominated bonds from sovereigns and quasi-sovereigns, and currently has an approximately equal split between bonds with investment grade and high yield ratings. Its TER is 0.45%.

The ETFs which will compete most closely with the new Vanguard ETF in terms of fees are the Amundi Global Emerging Bond Markit iBoxx UCITS ETF (Euronext Paris: AGEB) and the Lyxor iBoxx $ Liquid Emerging Markets Sovereigns UCITS ETF (LON: LEMB); each has a TER of 0.30%. The funds have $71m and $147m in AUM respectively.

SPDR ETFs and UBS also offer similar funds with TERs of 0.42% each.

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