Overseas Bond ETFs Get More Sophisticated

On top of shining a light on investor appetites each month, the fund flow data compiled by the National Stock Exchange also provides evidence of the persistent growth of the ETF universe.

Aside from recapturing the $1 trillion mark in October, investors watched the net population of exchange traded funds grow by 14. The breakneck expansion of the ETF universe is impressive, though expected. In their quests to secure market share and survive in the Darwinian environment, both new and veteran ETF sponsors have long sought to provide individuals with unique and attractive ways to gain access to the global marketplace. Today, using ETFs, investors can dice sectors, global markets, and other asset classes into increasingly thinner slices, allowing them tailor their portfolios to meet their personal investment demands. Not all corners of the ETF universe have evolved at the same pace however. On the contrary, in the case of bond ETFs, the growth has been relatively gradual. Whereas investors can turn to a variety of products when attempting to take aim at the domestic bond market, it has traditionally been difficult to gain exposure to international debt. In the past, I have directed investor attention to funds such as the iShares JPMorgan USD Emerging Market Bond Fund(EMB) and the SPDR S&P International Government Inflation Protected Bond ETF(WIP). While effective in targeting the debt of popular foreign nations, these funds may leave something to be desired. For example, both funds take aim at foreign debt using broad brush strokes. While investors can use equity-backed products to target individual nations or single sectors within a specific country or region, those looking to expand the reach of their fixed income portfolios beyond the U.S. borders have been forced to take a wide-net approach. The tide, though, appears to be shifting as seen by the recent batch of new fund launches. In September and October, fund companies including Guggenheim, Van Eck, Blackrock, PowerShares, and most recently, PIMCO, have unveiled products that are designed to hone in on the debt of individual nations. In addition to targeting single countries, the bonds underlying new products such as the PowerShares Chinese Yuan Dim Sum Bond Portfolio(DSUM) and the PIMCO Australia Bond Index Fund(AUD) are denominated in their local currencies.

The new batch of single nation local currency bond ETFs appears to have potential. Already, fund sponsors have had success with this corner of the global fixed income markets. Since their introduction during the latter half of 2010, broad-based local currency bond ETFs like the WisdomTree Emerging Markets Local Debt Fund(ELD) and the Market Vectors Emerging Markets Local Currency Bond ETF(EMLC) have taken off in popularity. As of the end of September, the funds boasted $1.08 billion and $511 million in net assets respectively.

In some cases, the benefit of this class of ETFs expands beyond allowing investors to target foreign fixed income markets. As I explained in recent weeks on ETFProfits, DSUM's yuan-denominated underlying holdings may make it an attractive option for those looking for exposure to the Chinese yuan. For now, I would encourage investors to stick to the sidelines here. So far, none of the newcomer products unveiled in recent weeks has generated the type of volume needed to be considered an adequately liquid option. DSUM's average volume, for example, has failed to surpass 5,000. In addition to potential liquidity issues, the current market environment does not bode particularly well for foreign currency-denominated assets. With the European economic crisis dominating headlines and driving many into safe haven asset classes, the U.S. dollar appears well-positioned for strength. With the greenback in vogue, other members of the currency spectrum will likely face headwinds. Single-nation local currency bond ETFs appear to be one of the more popular new frontiers for ETF sponsors. Though not currently the best bet, in time, these products could prove to be an attractive way for investors to further expand the international reach of their personal portfolios. Readers Also Like: >>3 Winning Investment Strategies>>10 Bulletproof Brands in a Bad Economy >To order reprints of this article, click here: Reprints