This post – part three of a Monevator deep dive into Emerging Market debt as an asset class – will compare the best Emerging Market bond ETFs and funds I can find.
The two previous posts examined the case for and against Emerging Market bonds:
Part one investigated the superior risk-adjusted returns of EM debt.
Part two dug into why the asset class’s historic out-performance may not be repeated.
While I think the argument in favour is marginal, I’m still tempted to invest in Emerging Market US$ sovereign bonds. I believe they may be a useful diversifier on the growth/risk side of my asset allocation.
But how do passive investors put money to work in this asset class? Which index trackers best match the returns of EM US $ sovereigns?
Read on for the pick of the best Emerging Market bond ETFs and funds.
Best Emerging Market bond ETFs and funds
Cost = OCF (%)
Sub-investment grade (%)
iShares Emerging Markets Government Bond Index Fund Class D Acc (USD)
JP Morgan EMBIGD1
Xtrackers USD Emerging Markets Bond ETF 2D
FTSE Emerging Markets USD Government and Government-Related Bond Select
Vanguard USD Emerging Markets Government Bond ETF Dist
Bloomberg Barclays EM USD Sovereign + Quasi-Sov
Invesco Emerging Markets USD Bond ETF Dist
Bloomberg Barclays Emerging Markets USD Sovereign
Legal & General Emerging Markets Government Bond (US$) Index Fund I Class
JP Morgan EMBI+3
All products are Emerging Market US$ sovereign bond funds (an ETF is just a type of fund), currency unhedged.
EM debt also divides into EM US$ Corporates and EM local sovereign. There’s no need to add these sub-asset classes as well. (Use GBP hedged ETFs if you do pick EM local sovereign, however).
See our best bond funds piece for quick explanations of table categories such as duration and yield-to-maturity.
iShares EM Gov Bond Index Fund publishes yield-to-worst data in its factsheet, not YTM.
Most providers don’t publish the average credit rating of their EM funds. I’ve included an estimate of sub-investment grade (junk) bond holdings as a placeholder for how much risk is embedded in these products.
The risk inherent in Emerging Market debt products means they behave like an equity/bond hybrid. For this reason, hold them in the growth portion of your asset allocation and not on the defensive side.
Selecting the best Emerging Market bond ETFs is not as straightforward as choosing the best global tracker funds. It’s certainly not as simple as picking the cheapest product and moving on. Every fund has an issue, which I’ll run through in two ticks.
But before we get into that, let’s do a performance check.
Best Emerging Market bond ETFs – results check
Source: Trustnet’s charting tool.
Important: Because past performance is no guarantee of future results, the right fund isn’t the one that did best last Tuesday, or even beat the pack by a nose over three years.
Rather, the point of the results check is to ensure that a dysfunctional product hasn’t crept onto the shortlist.
Maybe a fund doesn’t tracks its index well? Perhaps – despite its plausible sounding-name – it isn’t faithful to the industry-standard view of Emerging Market US$ sovereign bonds?
Comparing returns can reveal a fund that doesn’t behave as expected.
Even a runaway winner should ring alarm bells. It’s vanishingly rare for one index tracker to trounce its rivals. They’re meant to be me-too products.
I’m also not keen on drawing conclusions from any less than five years of data. More is better.
Strangely, Trustnet doesn’t have returns for the iShares Emerging Markets Government Bond Index Fund. That adds to the mystery surrounding this tracker (see below).
Meanwhile, over five years, the iShares JP Morgan $ EM Bond ETF (Ticker: SEMB) soundly beat its long-toothed L&G rival, despite costing more.
That’s one of the reasons the L&G index fund is at the foot of our table.
Wider selection criteria
I’ve gone through these index trackers with my finest tooth comb and uncovered a few bugs.
Firstly, it’s important to know that the index is key for EM US$ sovereign bonds.
Monevator reader and hedge fund quant, ZXSpectrum48k, explained that institutional investors overwhelmingly use the JP Morgan Emerging Markets Bond Index Global Diversified Index (JPM EMBIGD). It’s highly diversified and includes a 10% cap on the weighting of each country.
Why do institutional bond investors insist on capped indices? ZX is in the know:
This is to mitigate the impact of an ever-increasing weighting to an issuer (sovereign or corporate) that is declining in credit quality but also to offset the reduced diversification that can result from this effect.
Capped indices are now totally dominant in emerging government bond markets. Only retail use uncapped indices (they are cheaper to buy from index providers).
The ideal index is the JPM EMBIGD
Only iShares’ Emerging Markets Government Bond Index Fund tracks the JPM EMBIGD.
This fund also happens to be the cheapest retail EM US$ debt tracker by OCF. And it looks good on other metrics, too.
There’s only one problem – I can’t find it in the real world!
A Google search doesn’t reveal any other platforms stocking it, either.
Yet it’s listed on iShares’ retail website in Class D shares. That share class is typically used by other iShares index funds that are available to retail investors like you and me.
And the fund was launched in May 2018, so it isn’t new.
Is it available on your platform? Please let us know in the comments below.
Often platforms will list funds when they’re nudged by customers. Perhaps there just isn’t enough demand for it in retail-land.
The next best thing: JPM EMBIGC
EMBIGC stands for the Emerging Markets Bond Index Global Core. It’s a cut-down version of the EMBIGD.
ZX compares EMBIGC to its premium counterpart like this:
This [EMBIGC] excludes many less liquid, higher yielding countries, and knocks around 70bp off the yield.
iShares JP Morgan $ EM Bond ETF (Ticker: SEMB) tracks the EMBIGC.
You can spot the difference the index makes by comparing SEMB’s data with the EMBIGD-hugging iShares Emerging Markets Government Bond Index Fund.
SEMB lags the index fund by 0.24% annualised over three years.
According to iShares, the EMBIGC index trails the EMBIGD by 0.19% over three years.
That implies the SEMB ETF isn’t too shabby, even though its OCF is 0.27% chubbier than the index fund rival. We might have expected SEMB to lag by a much higher amount, given the combined OCF and index differential.
It’s also reassuring to see the two trackers’ Top 10 geographic exposures are similar. Same countries, with less than 1% difference in weight.
Maybe that tiny difference is mission critical to institutional investors with billions under management, but it doesn’t matter much to me. I’d be happy to hold SEMB instead of the EMBIGD-tracking index fund, especially when my platform’s fees favour ETFs.
Yes, SEMB’s holdings are slightly less diversified. But they’re spread more widely than the rest of the shortlist.
I’ll have to stop mooning after the index fund if it isn’t available, anyway.
The best of the rest
The other index trackers are all cheaper than SEMB by OCF.
The only one that stands out though is Vanguard’s USD Emerging Markets Government Bond ETF. It’s got a shorter duration (and hence a lower yield) than the pack. And it holds less junk.
The Xtrackers and Invesco ETFs both have niggling index discrepancies.
The Xtracker product tracks the FTSE Emerging Markets USD Government and Government-Related Bond Select index. But its index’s ticker is different from the index of the same name published by FTSE Russell.
Such inconsistencies make me feel like I’m missing something.
The Invesco ETF’s index isn’t listed on the Bloomberg Barclays site. I don’t like it when information is hard to find or non-existent.
The Invesco ETF’s index does sound superficially similar to the Vanguard ETF’s index. But the holdings of the two funds are distinct. And information about Vanguard’s index is published on Bloomberg Barclays.
What’s going on here? For now I just see red flags.
Meanwhile, L&G’s Emerging Markets Government Bond (US$) Index Fund tracks the JP Morgan EMBI+ index.
This is an older, less diversified member of JPM’s EM US$ sovereign bond index family that includes EMBIGD and EMBIGC.
L&G’s fund is the least diversified on our list. And I won’t invest when a provider doesn’t publish data like yield-to-maturity on its fund’s webpage.
Cap my ass
The JPM EMBI+ is pure market cap. This means it’s dominated by countries issuing large amounts of debt. That helps explain why the L&G fund is the least diversified on our list.
Meanwhile, there’s no mention of a country weighting cap on the Bloomberg Barclays EM USD Sovereign + Quasi-Sov index’s factsheet.
Vanguard’s ETF is thus more heavily concentrated in its top 10 countries than the others, bar L&G. It holds more individual securities, though.
The JPM EMIGC factsheet does reference a maximum weight per country. But it doesn’t say what it is!
Xtrackers states its ETF’s index country cap is US$25 billion. Its top 10 is as moderately concentrated as the EMBIGD index fund, although the country mix is quite different.
The Invesco ETF’s index sounds similar to Vanguard’s but is less concentrated, especially in China.
Fund providers get extra integrity points for publishing their product’s transaction costs.
Transaction costs can undermine your returns, and they aren’t captured by the headline OCF fee.
Only Xtrackers is courageous enough to publish its ETF’s transaction cost on its webpage.
That cost is 0.11%, which accounts for the dealing fees notched up by the product in a year. It’s a large extra cost percentage, on top of the 0.25% OCF.
Vanguard publishes transaction costs, too, but buried in a PDF in a dark corner of its site. Add 0.09% to the cost of its Emerging Market bond ETF.
If the rest do publish transaction costs then they don’t make them easy to find. (Funny that.)
Until they do, I’ll assume transaction costs are at least 0.11% for the rest of our line-up.
Bond fund taxation is heavier than equities. That matters if you hold them outside your ISA or SIPP, and/or they burst the banks of your tax allowances.
Offshore bond funds are taxed at a higher rate still, if they don’t have reporting fund status.
Our shortlist all claim reporting status except the L&G fund, which doesn’t need it (UK domiciled), and iShares enigmatic index fund, which doesn’t bother saying one way or the other. (Truly this fund is too cool for school.)
As a passive investor I have no opinion on the differing degrees of credit risk embedded in each of these products.
I want to take the same amount of risk as the wider market because I have no edge over the market.
So I don’t think of average credit rating (or junk bond holdings) as a selection criteria for the best Emerging Market bond ETFs and funds – as long as its roughly in line with the market’s view.
The market is best represented by the leading EMBIGD index, which posts an overall credit rating of BB+ on its factsheet. The caveat is that EMBIGD’s latest factsheet is dated 2018.
We can also use the iShares Emerging Market Government Bond Index fund as an EMIGD proxy, because it follows the index.
Only Vanguard and Invesco actually publish average credit ratings (BBB- and BBB respectively).
Gauging by the junk bond holdings of the iShares and Xtracker ETFs, they’re a little riskier, which looks about right.
So that’s my best assessment of where things stand with emerging market sovereign bond ETFs and funds right now.
Apologies if it comes across as more of an artist’s impression than a blueprint. And please do add your own strokes in the comments below.
Part four in this once-thought-to-be-one part series will run through a very naughty Emerging Market bond valuation rule-of-thumb that is in no way to be relied upon.
Until then, take it steady,
Emerging Markets Bond Index Global Diversified
Emerging Markets Bond Index Global Core
Emerging Markets Bond Index Plus