Industry Updates

Emerging market bond ETFs suffer exodus on monetary policy squeeze

ETFs exposed to emerging market debt saw combined outflows of more than $1bn last week

Jamie Gordon


Emerging market bond ETFs have been casualties of the broader shift out of the asset class this year as rising interest rates in western economies and a strong US dollar diminish the appeal of developing market debt exposure.

According to data from ETFLogic, the $6.6bn iShares J.P. Morgan $ EM Bond UCITS ETF (SEMB) saw $513m outflows in the week to 29 September while investors withdrew $225m from the $3.6bn iShares J.P. Morgan Local Govt Bond UCITS ETF (SEML) over the same period.

Interestingly, $5.2bn the iShares China CNY Bond UCITS ETF (CNYB) – which booked billions of inflows last year – has continued to struggle with outflows of $372m exodus over the past week. CNYB has seen $6.4bn outflows so far this year, as at 4 October.

The rush to the exit in emerging market debt follows the Federal Reserve’s third successful 0.75 basis point hike a fortnight ago, which pushed yields on US Treasuries upwards and made the traditionally higher yields offered by emerging market bonds look less attractive.

China’s 10-year government bond, for instance, currently offers a yield of 2.78%. The equivalent US Treasury, meanwhile, is currently yielding 3.59% after rising 40bps over the past month.

The unfavourable yield spread dynamic is also having an effect in emerging market debts more broadly – and outside of China, whose sovereign yields tend to be more rigidly priced. 

Over the past month, SEMB and SEML returned -4.5% and -4.2%, respectively, as asset prices suffered and yields were pushed higher and investors demanded higher yields to take on developing market debt exposure.

The Fed’s decision to increase rates once again by their joint-highest margin since the turn of the century has also entrenched the US dollar’s position as the strongest hard currency, which makes it more difficult for borrowers to pay off dollar-denominated debt.

The combination of these pressures has seen emerging market bond funds globally book a record $70bn outflows so far this year according to JP Morgan, with the bank now increasing its expectations for outflows from the asset class to $80bn for the full year, up from $55bn previously.

However, the recent sell-off is in contrast to what was seen in August when a lower-than-expected US consumer price inflation reading (CPI) and more moderate tone from Fed Chair Jerome Powell inspired investors to become more risk-on, with SEMB enjoying $366m inflows in the week to 12 August.

This optimism now seems to have been replaced by a broader rush for safety by investors as stubborn headline inflation readings, continued central bank hawkishness and the seeming inevitably of recession all put pressure on more risk-on fixed income exposures.

During the difficult week for emerging market bond ETFs, the $3.8bn iShares € High Yield Corp Bond UCITS ETF (IHYG) also suffered $372m outflows, according to data from ETFLogic.

Despite the challenging backdrop, BlackRock remains relatively optimistic about emerging market debt.

The asset manager said in its weekly market outlook: “We are overweight emerging market debt. Central banks are well ahead of others in their cycles. Emerging market currencies have also held up fairly well in the risk-off environment.

“But we remain wary of the currency outlook as some central banks in emerging markets have paused their tightening as growth deteriorates.” 

However, it did note its view on local currency-denominated bonds was more positive, whereas it was neutral on US dollar-denominated debt.

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