iShares J.P. Morgan EM Corporate Bond ETF (BATS: CEMB)

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Corporate Bond ETFs: An Alternative to EM Sovereigns

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PowerShares Emerging Markets Sovereign  Portfolio

Under the Hood: And There Was Three (EMCD, CEMB, EMCB)

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State Street to Introduce 2 New Bond ETFs Tuesday

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Investors embraced emerging markets sovereign debt, both the dollar-denominated and local currency varietals, in significant fashion last year. 

Returns generated by <a href="http://www.benzinga.com/markets/bonds/13/02/3306771/low-vol-etf-leads-powershares-2012-inflows">and inflows to the ETFs</a> tracking this asset class affirm that assertion.

Due to higher yields than what is available on U.S. Treasuries and other developed market bonds and, in many cases, stronger government balance sheets, emerging markets sovereign debt has attracted an increasingly large following among developed market investors. However, there is an alternative that should not be ignored.

That being emerging markets corporate debt. Previously inaccessible via ETFs, developing world corporates made a splash on the ETF scene last year when the WisdomTree Emerging Markets Corporate Bond Fund (NASDAQ: <a class="ticker" href="/stock/emcb#NASDAQ">EMCB</a>) debuted in March. 

Those that thought emerging markets corporates would be too much of niche play for most investors have had to eat their words. EMCB <a href="http://www.benzinga.com/markets/bonds/12/10/3036081/investors-pouring-cash-into-em-bond-funds">had $88 million in assets under management in late October</a>. That number now resides at $126.6 million. Translation: EMCB' AUM total has surged almost 44 percent in five months.

So successful has EMCB been that it prompted the creation of not one, but two copycat funds, the iShares Emerging Markets Corporate Bond Fund (NYSE: <a class="ticker" href="/stock/cemb#NYSE">CEMB</a>) and the SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (NYSE: <a class="ticker" href="/stock/emcd#NYSE">EMCD</a>). Proliferation and success of ETFs are not the only reasons investors should consider developing world corporates.

"Due to growth in new issuance, the investable universe of emerging market (EM) corporate debt is now larger than the market for EM U.S. dollar (USD) sovereigns," said WisdomTree Portfolio Manager Rick Harper in a new research note. "On average, EM corporate bonds currently feature higher credit quality, less sensitivity to changes in U.S. interest rates, and offer greater incremental income potential than EM USD sovereigns."

Harper's observations jibe with comments made by <a href="http://www.benzinga.com/analyst-ratings/analyst-color/12/10/3043478/pimco-bullish-on-em-corporate-bonds">PIMCO in late October</a>. 

In a note written by PIMCO's Ignacio Sosa and Anton Dombrovsky, the bond house said "the dollar-denominated EM corporate market has been growing steadily, and many corporates can offer higher yields and lower durations than sovereigns."

As of the end of January, the J.P. Morgan EMBI Global EM USD Sovereigns universe had a market size of just under $572 billion compared to a market size of nearly $624.5 billion for the J.P. Morgan CEMBI Broad EM Corporates realm, <a href="http://www.wisdomtree.com/blog/index.php/gaining-exposure-to-emerging-market-credit-risk/?elqCampaignId=302">according to WisdomTree data</a>.

The data confirm Harpers comments about superior credit quality and less sensitivity to U.S. interest rate fluctuations. Over 73 percent of the aforementioned emerging markets corporate bond gauge is rated investment-graded compared to less than 62 percent for the sovereign debt index. 

Average duration for the corporates is 5.59 years compared to 7.5 years for the sovereigns. Duration measures a bond's sensitivity to interest rate changes.

Evidence has started to mount that EM corporates represent a valid alternative or complement to sovereign debt.

"We believe that the factors that led to EM USD sovereign outperformance may be waning," said Harper. "In our view, EM corporate bonds offer the next wave of opportunities in EM fixed income. For example, in Russia, investing in corporate bonds as opposed to government debt resulted in a 1.64% increase in yield, with less interest rate risk as of February 15, 2013."

With an allocation of 20.99 percent, Russia is EMCB's second-largest country weight behind Brazil. Mexico, Hong Kong and Colombia round out the top-five country weights in the ETF. EMCB also features exposure to Jamaica, Kazakhstan and Venezuela, among others, and that may have investors pondering if they will be adequately compensated for the perceived added risk.

"In an investment environment where investors are constantly questioning whether they are being adequately compensated for the amount of credit risk they are assuming, they are simultaneously confronting the prospect of higher long-term interest rates," Harper said. "We believe EM corporate debt could provide an attractive solution to this dilemma. By enhancing yield potential and overall credit quality, while at the same time reducing interest rate risk, EM corporate bonds could provide attractive total returns compared to EM USD sovereign debt in 2013."

Indeed, EM corporates do feature attractive yields. The average yield to maturity on investment-grade bonds in J.P. CEMBI Broad EM Corporates Index is 36 basis points higher than the highly-rated issues in the sovereigns index. For the junk issues, the yield-to-maturity difference is 39 basis points in favor of corporates, though corporates often feature better yields than government debt.

A more relevant comparison is EMCB to the iShares iBoxx $ Investment Grade Corporate Bond Fund (NYSE: <a class="ticker" href="/stock/lqd#NYSE">LQD</a>), the largest corporate bond ETF by assets. EMCB has a 30-day 3.78 percent compared to 2.9 percent for LQD. EMCB's effective duration is 6.17 years compared to 7.69 years for LQD.

One of the more noteworthy themes in ETF Land this year has been the rise of emerging markets bond funds. Scores of <a href="http://www.benzinga.com/markets/bonds/12/05/2573177/a-look-at-the-new-em-junk-bond-etf-hyem">new emerging markets bond ETFs</a> have come to market and previously existing funds have delivered impressive performances.

The following illustrates just how impressive select emerging markets bond ETFs have been this year: In the past 90 days, the PowerShares Emerging Markets Sovereign Debt ETF (NYSE: <a class="ticker" href="/stock/pcy#NYSE">PCY</a>) has outperformed the much ballyhooed PIMCO Total Return ETF (NYSE: <a class="ticker" href="/stock/bond#NYSE">BOND</a>) by nearly 130 basis points. 

In fact, PIMCO's Bill Gross recently said bond investors "should favor quality and 'clean dirty shirt' sovereigns" such as <a href="http://www.benzinga.com/markets/bonds/12/06/2702422/etfs-bill-gross-might-like-bono-hdv-pbj#ixzz20XHGJHgs"> (U.S., Mexico and Brazil)</a>.

Buoyed by positive sentiment from <a href="http://www.benzinga.com/markets/bonds/12/04/2524308/koesterich-likes-corporate-debt-em-bonds-lqd-emb-lemb">other experts</a> in addition to Gross, emerging markets bond funds have flourished in number and performance this year.

Regarding some of the new kids on the block, funds offering exposure to emerging markets have finally made it onto the scene, led by the WisdomTree Emerging Markets Corporate Bond Fund (NASDAQ: <a class="ticker" href="/stock/emcb#NASDAQ">EMCB</a>). EMCB debuted in March and has hauled in more than $61 million in assets under management, making it one of the more successful new ETFs of 2012. 

Five weeks later, the iShares Emerging Markets Corporate Bond Fund (BATS: CEMB) came along and that fund has been fair in terms of attracting AUM with $10.2 million. 

Those that think two emerging markets corporate bond ETFs is enough should think again because EMCB and CEMB have a new rival in the form of the SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (NYSE: <a class="ticker" href="/stock/emcd#NYSE">EMCD</a>).

Not even a month old, the ETF is showing it is a valid competitor to EMCB and CEMB. In fact, the SPDR offering has already raked in almost $15.3 million in AUM, putting it well ahead of its iShares rival in that regard.

Granted, the data set is small, but since the SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF started trading, it has outperformed the PIMCO Total Return ETF by 230 basis points and its iShares counterpart by almost 170 basis points.

'Me too' ETFs, and the SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF is certainly one, often find tough sledding when competing against entrenched rivals. Simply put, human nature dictates that most investors are not apt to switch to a new ETF over an older version unless the new fund really has something special to offer. 

In the case of EMCD, it has one significant point in its favor: It charges 0.5 percent per year in fees. That is 10 basis points cheaper than what EMCB and CEMB charge.

EMCD features 83 holdings, a small number relative to the 461 featured in the fund's index. The ETF has a 30-day SEC yield of 3.06 percent and the index's current yield is 5.55 percent, according to data on the SPDR website. 

More than 76 percent of EMCD's holdings are rated A or Baa and approximately 87 percent have maturities ranging from two to 10 years. Issues from Brazil, Russia and Mexico comprise about 45 percent of the fund's country weight while bonds issued by the United Arab Emirates, South Korea, Hong Kong, China, India and Qatar make up the rest of the fund. 

Bottom line: by total return and assets attracted, there is no denying EMCD is off to a banner start. While not impossible, EMCD usurping EMCB for the title of the largest emerging markets corporate bond ETF is not probable in the near-term. However, EMCD looks like it has already trumped its iShares rival for the number two spot.

For more on emerging markets bond ETFs, click <a href="http://www.benzinga.com/markets/bonds/12/05/2565731/the-definitive-guide-to-non-usd-em-bond-etfs">here</a>.

State Street's (NYSE: <a class="ticker" href="/stock/stt#NYSE">STT</a>) State Street Global Advisors unit, the second-largest U.S. ETF sponsor, will introduce two new bond ETFs on Tuesday. 

The SPDR BofA Merrill Lynch Crossover Corporate Bond ETF (NYSE: <a class="ticker" href="/stock/xovr#NYSE">XOVR</a>) will track an index that offers exposure to dollar-deonominated U.S.-issued BBB and BB-rated corporate debt. BBB is the lowest investment grade rating and BB is a non-investment grade rating. 

Qualifying securities must have at least one year remaining term to maturity, a fixed coupon schedule and a minimum amount outstanding of $250 million. Original issue zero coupon bonds, 144a securities, both with and without registration rights, and pay-in-kind securities, including toggle notes, qualify for inclusion. Callable perpetual securities qualify provided they are at least one year from the first call date. Fixed-to-floating rate securities also qualify provided they are callable within the fixed rate period and are at least one year from the last call prior to the date the bond transitions from a fixed to a floating rate security, according to <a href="http://www.sec.gov/Archives/edgar/data/1064642/000119312512063429/d300862d485apos.htm#pro300862_3">XOVR's prospectus</a>.

SSgA will also introduce the SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (NYSE: <a class="ticker" href="/stock/emcd#NYSE">EMCD</a>). Other ETF sponsors have already found success with emerging markets corporate bond ETFs, a fact that could either bode well for the SPDR BofA Merrill Lynch Emerging Markets Corporate ETF or indicate the ETF is late to the party.

The WisdomTree Emerging Markets Corporate Bond Fund (Nasdaq: <a class="ticker" href="/stock/emcb#Nasdaq">EMCB</a>), which debuted in March, now has almost $60 million in assets under management. The iShares Emerging Markets Corporate Bond Fund (BATS: CEMB), which debuted in April, has over $10 million in AUM.

Expense ratios were not included in the prospectus for either XOVR or EMCD.

iShares J.P. Morgan EM Corporate Bond ETF declares monthly distribution of $0.1822

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iShares J.P. Morgan EM Corporate Bond ETF declares monthly distribution of $0.1861