Behemoth exchange-traded fund issuers like iShares can't do everything. They don't do the best job, for example, of developing targeted thematic portfolios. But they do have sweet spots.
I'm looking in particular at the Feb. 24 launch of the iShares J.P. Morgan Broad USD Emerging Markets Bond ETF (BEMB) . You may ask yourself, "but Mark, you're an equity and options guy, what do you know about fixed income?" I would answer that, back in the day, I worked at fixed income manager Loomis Sayles and a little later on was part of the team that brought the Morgan Stanley Emerging Market Domestic Debt Closed-End Fund (EDD) to market. Old habits, as they say. In any event, let's take a look at BEMB.
Of Sovereigns and Corporates
If you're wondering, the term sovereign debt refers to bonds issued by governments, the rest of the world's version of U.S. Treasuries. "Quasi-sovereign" refers to bonds issued by groups whose activities are supported by governments or corporations that are partially owned by governments. It is important to note that while governments may be involved in the financing of group activities or have ownership in a company, it does not mean they are providing guarantees for the debt of either.
Supranational debt is another type of sovereign-affiliated debt that is essentially multi-sovereign, or quasi-sovereign, or both. Examples include the European Union, the United Nations, and the World Trade Organization.
Corporate debt is the same globally as it is here. Corporations issuing debt to finance activities.
While establishing the credit quality of these issues may get complicated, the basic bond math of the various yield (yield to maturity, to worst, to call) and duration calculations remains the same.
There are many differences between equities and bonds, but one of the biggest differences that often gets overlooked by investors is that the global bond market, with the exception of some electronic trading platforms, is still an over-the-counter (OTC) market. Further, don't forget that each issuance of debt is for a set amount of borrowing and often, deals are announced and some of those bonds essentially disappear until maturity once they're purchased. While this isn't the case with all bonds, it underscores the point that many bonds don't have a huge amount of liquidity, especially when compared to stocks. Liquidity matters because each transaction provides an opportunity for the market to put a value on the security in question, or, as the street likes to say, conduct "price discovery."
Because of this issue of not being able to refer to a real-time trade feed to source bond prices, issuers will often rely on third-party services to provide these prices to them. There have been exceptions in the past (notably Pimco) where regulators allowed an issuer to produce their own security valuations but in this post-LIBOR world, you're not likely to find this anymore. In reading through the prospectus for BEMB, iShares doesn't spell out their pricing source but the index methodology states that index provider J.P. Morgan uses its own Pricing Direct service which touts its use of "market-based cash flow generators, innovative option adjusted spread (OAS) modeling techniques, and real-time access to primary and secondary markets to produce evaluated pricing and analytics." While not explicitly stated (that I could find anyway) it seems like iShares will be using index constituent prices to strike their daily Net Asset Value (NAV).
To be clear, neither J.P. Morgan nor iShares are doing anything weird, odd, or otherwise different from anyone else in this space. Still, if you decide to purchase shares of BEMB as part of a tactical allocation in your portfolio it might pay (literally) to read the disclosure on page S-10 of the prospectus regarding "Valuation Risk."
BEMB: Boom or Bust?
As mentioned, the peculiarities and risks associated with emerging market debt are not unique to BEMB. One note about this fund is that even though it is an emerging market debt fund, the bonds it holds are both issued in U.S. dollars and make interest payments in dollars, so while a currency risk is present in these bonds, it is borne by the bond issuers, and not the fund.
In reviewing the current holdings and doing a little bit of math, the fund is 66% government/ quasi/ supranational debt, about 30% corporate debt, and 3.50% cash. There are 54 issuers represented with the top 10 countries totaling roughly 40% of fund assets. Top 5 holdings include China, Oman, Mexico, Brazil, and Saudi Arabia. Also included in the mix are countries like Ukraine, El Salvador, and Lebanon, which lines up with the prospectus stating that up to 15% of the fund can be held in illiquid debt but in this case, these countries amount to just under 0.60%.
By my calculations, the fund currently has a 5.78-year duration and a yield to maturity of 6.65%. Based on my review of the holdings file there do not seem to be any callable securities. Maturity-wise most holdings seem to be in the 4 - 7 year range although there are some long-dated bonds with maturities in 2050 and even some in 2079.
Wrap It Up
As I mentioned at the beginning of this article, if there was a space in which iShares had the size and experience to navigate, it would be this one. If you are looking for exposure to USD-issued and interest-paying emerging market debt and are indifferent to the politics of holding certain countries' bonds, I don't see why you wouldn't add BEMB to your allocation.
