In a recent LearnBonds article, Marc Prosser shared some of Sergio Trigo Paz’s thoughts presented at BlackRock’s “Fixed Income Roundtable.” Paz is a Managing Director and Head of BlackRock’s Emerging Markets Fixed Income within the Portfolio Management Group.
One of the takeaways was that Paz mentioned discussions he was having with investors who were matching income flows from emerging markets bonds they were buying to specific liabilities. I have long suspected matching bond cash flows to specific liabilities would become more and more pronounced as insurance companies and pension funds got closer to dealing with the consequences of baby boomers nearing retirement. I contend this will continue to occur not just with respect to emerging market bonds, but also with other sovereign and corporate debt around the world. It is interesting to note that when large institutional players are matching cash flows to specific liabilities, and yields across the fixed income universe are exceptionally low, the low yields themselves can actually act as a rather significant catalyst for continued demand for bonds. After all, if you have, say, $1 billion of liabilities to meet, you have to buy a whole bunch more bonds when rates are as low as they are today than you would at the interest rates of years gone by.
That might explain another takeaway from the “Fixed Income Roundtable”—that investors are turning to emerging market bonds because they can get a little more yield simply for buying the debt of a company with a name that most investors don’t recognize. Getting a little extra yield for what some investors would consider comparable credit risk can help those institutional investors more easily meet their liabilities. It also helps to explain why, according to Paz, insurance companies and pension funds are looking to double their investments in emerging market bonds.
How do everyday investors take advantage of this? It is not the easiest task for retail investors to build a diversified portfolio of emerging market corporate bonds. One can, from time to time, find dollar-denominated bonds of foreign companies listed on a retail brokerage bond platform. But non-dollar-denominated bonds are much harder to come by. There are, however, a variety of funds available that offer exposure to emerging markets fixed income. One such fund is the iShares Emerging Markets Corporate Bond ETF (CEMB).
CEMB is both a small (by net assets) and new fund. Its inception date was about a year ago, on April 17, 2012, and it currently has roughly $37 million in total net assets. The fund tracks the Morningstar Emerging Markets Corporate Bond Index, which is a benchmark for fixed rate, U.S. dollar-denominated debt from corporations in Latin America, Asia (excluding Japan), Eastern Europe, the Middle East, and Africa. Each security selected for the index must have a minimum outstanding face value of $500 million and belong to an issuer with outstanding debt of $1 billion or more. The securities must also have at least 13 months remaining until maturity.
As of April 8, 2013, the fund had 234 holdings, most of which carried investment grade ratings. On the same date, S&P had non-investment grade ratings on 16.12% of the fund, and Moody’s had non-investment grade ratings on 13.34% of the fund. Moreover, 18.29% and 11.42% of the fund’s bonds were not rated by S&P and Moody’s respectively. It is worth noting that according to the December 31, 2012 iShares Fact Sheet for CEMB, the Morningstar index it tracks had 513 holdings.
The weighted average maturity of CEMB is 8 years, while the effective duration is 5.64. 84.21% of the fund’s holdings have one to ten years to maturity. In terms of the country breakdown, Brazil holds the top spot at 14.07%, followed by Russia (9.00%), Mexico (8.77%), and South Korea (8.11%). It is worth noting that despite being an emerging markets fund, iShares is reporting the United States, at 4.54%, as CEMB’s 8th largest holding by country. The sector breakdown is dominated by just three. Industrials make up 55.77% of the fund, followed by Financials at 26.97%, and Utilities at 9.26%.
Finally, two pieces of information that investors are often eager to know about a fund are the expense ratio and the yield. CEMB’s expense ratio is 60 basis points (0.60%), and the 30-day SEC yield is currently 3.33%.
Now it’s time to answer the question posed in the title of this article: Is CEMB worth owning? While I would guess there are some investors for whom this fund is desirable, there are a few things that make me want to pass on it at this time. First, the yield is simply too low. There is currently not even one fixed income security in my portfolio that pays me a coupon or distributions (from an ETF) with an annual yield as low as 3.33%. I would like to keep it that way for as long as possible. Second, it makes me a bit uncomfortable that CEMB seeks to track the returns of an index of which it owns less than half the holdings. Perhaps there is a great reason for not owning over 200 of the Morningstar index’s holdings. I would guess it can be quite difficult finding a sufficient quantity of some of the bonds. But if a fund provider explicitly states that a fund will seek to track the investment returns of a particular index, I’d prefer the fund own far more than half of that index’s holdings. Last, I don’t like the fact that this fund consistently trades at a decent premium to its net asset value (NAV). At this time, CEMB’s price is 1.30% higher than its NAV, and at no point during the last two quarters has the fund traded at a discount to NAV. Perhaps I am a bit fastidious when making a purchase for my portfolio. But when buying an ETF, I appreciate the opportunity (as others have afforded me) to purchase at a discount to the net asset value (however small the discount may be).
On the other hand, there are three things I do particularly like about the fund. First, I like that it pays monthly distributions. Individual bonds usually pay semiannual distributions. It can be nice to get a more frequent payout. Second, I like the minimum size requirements for the outstanding debt of individual securities and issuers included in Morningstar’s index (which CEMB tracks). And third, I like the geographic diversity of the fund. Even though the yield is currently a non-starter for me, I will keep this fund on my radar screen in case a time should come when it is a bit more enticing.
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