Another Growth Frontier For ETFs

Fixed income exchange traded funds have long viewed as an important growth avenue for the broader ETF industry. That theme has been on display this year as bond ETFs broke annual inflows records with several months left in the year.

Emerging markets bond funds are among the fixed income ETFs that are experiencing rapid growth. There is plenty of room for that growth to continue. Around the world, investors allocate $500 billion to emerging markets debt, but just about $50 billion of that total is devoted to ETFs. The VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (NYSE:EMLC) controls a tidy $4.2 billion of that total.

Although the Federal Reserve and some other developed markets central banks are considering interest rate increases, rates are low and, in some cases, negative, throughout the developed world. That is one of the factors prompting investors to consider emerging markets debt.

Expect More Inflows

EMLC is on a torrid pace of asset gathering this year. Investors have allocated $1.75 billion in new capital to the ETF year-to-date, a hefty percentage of the fund's overall assets under management. It is reasonable to expect this trend will continue for EMLC and rival funds.

Year-to-date through October, ETFs garnered 23 percent of net inflows into the asset class globally and 49 percent in the U.S., said Van Eck in a recent note. Additionally, over the past four years, while other vehicles have experienced outflows, flows into ETFs have been positive.

EMLC, which holds 270 bonds, has a 30-day SEC yield of 5.87, which is a source of allure for income-starved investors. Over 53 percent of the ETF's holdings are rated A or BBB.

Addressing Liquidity Concerns

When it comes to ETFs tracking more nuanced corners of the bond market, such as emerging markets debt and junk-rated corporates, investors are often concerned about liquidity. Data suggest emerging markets bond ETFs offer robust liquidity and may be better ideas than individual issues.

Despite the questions that have been raised about the liquidity of these products (and bond ETFs in general), secondary market liquidity has held up through these various events, said VanEck. Ultimately, the underlying bonds drive liquidity and ETFs are no different from either mutual funds or separate accounts in this respect. However, ETFs provide an additional layer of secondary market liquidity, particularly for larger and heavily traded funds, potentially resulting in lower trading costs for investors.

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