If there is one area where exchange-traded funds (ETFs) are making headway in the Canadian pension space, it’s in emerging markets. My own discussions with plan sponsors about their ETF use often reveals at least one emerging market equities product in the investment mix, as plan sponsors turn to ETFs for added liquidity or exposure to the asset class as they search for an active manager.
But as global institutional investors—along with Canadian plan sponsors—get ready to ramp up their exposure to emerging markets, equities tend to be the first choice, with fixed income as a distant second, as memories of the Asian flu of the 1990s loom large (along with a lingering malaise from Russia and Mexico).
But that could be changing, according to a note from iShare’s Russ Koesterich. In a recent research note, Koesterich points to signs that investors are revisiting the risk profile of emerging market debt. In particular, he cites some interesting data that shows a clear decline in credit default swaps (CDSs) for many emerging market issuers. In fact, the shift has happened as more and more investors are buying CDS contracts in developed markets.
It’s a role reversal that has been taking shape for the past several years, said Koesterich. As the credit crisis ravaged developed markets, the credit quality of emerging market debt issuers has improved dramatically, with many countries making major improvements to their fiscal positions and now boasting balance sheets that look a lot better than those of European countries or the U.S. These days, 60% of the JP Morgan Emerging Markets Bond Index is investment grade. And as investors struggle with low interest rates and poor yields on longer-dated instruments, they are beginning to look seriously at emerging market bonds as a viable alternative.
For plan sponsors that have been turning to ETFs for their emerging market exposure, there are few products on offer that could give them a slide of exposure to the asset class that is easy to come by and relatively liquid. And a few local currency products also offer exposure to any appreciation in emerging market currencies as those balance sheets get stronger and as these countries continue to draw serious attention from investors.
For many Canadian pension plans, emerging market debt ETFs could be a stretch—but they’re definitely worth a second look, especially as plan sponsors become more comfortable with emerging market equities and as they continue to face a possible bond bubble.