Emerging Markets Bond ETF (EMBD): Q2 2022 Commentary


The Index tracks emerging market (EM) liquid US dollar-denominated fixed and floating rate debt securities issued by sovereign and quasi-sovereign entities.

Performance data quoted represents past performance and does not guarantee future results. Investment returns and the principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost. Actual performance may be higher or lower than stated performance. For up-to-date performance data through the end of the most recent month or quarter, please Click here. Total fee rate: 0.39%.

Cumulative return is the total amount an investment has gained or lost over time.

General Market Review

During the period, risk assets came under pressure as investors continued to price in further interest rate hikes and the US Federal Reserve (Fed) reiterated its commitment to controlling inflation. The Fed began its rate hike cycle in March with a 25 basis point (bp) hike, followed by 50 bp and 75 bp hikes in May and June. Signs of a slowdown began to appear as the US Purchasing Managers’ Index (PMI) indicated a deceleration in growth momentum, with the PMI falling to 52.7 in June from 57.0 in May.¹ The fears Growing signs of a recession due to aggressive Fed rate hikes seem to be outweighing market concerns about inflation. The 10-year US treasury rate rose 66 basis points to 2.98% at the end of the quarter as inflationary data and further rate hike expectations were transmitted to the treasury markets.

Russia continued to be a major underperformer due to their continued invasion of Ukraine. At the end of March, Russian securities were zero-marked by the index provider and became non-tradable due to sanctions imposed by Western countries. Sanctions intensified during the period as the US Office of Foreign Assets Control (OFAC) decided not to extend the 9A General License, implying that US bondholders would not be allowed to continue receiving payments after the clause expires on May 25. At the time, Russia had about $100 million in interest payments for various USD and EUR denominated bonds due May 27 with a 30-day grace period until June 26. Although Russia announced that it had sent the payments to the National Settlement Depository (NSD) for settlement on the original due date, the termination of the 9A General License and the European Union (EU) sanctions put in place working against the Russian NSD left the funds blocked at the NSD. Indeed, Russia defaulted on its foreign currency debt, but market contagion was insignificant as investors had been expecting Russia to default for several months.

Belarus, Lebanon, Sri Lanka and Ukraine were also among the five worst performing countries during the period. Sri Lanka has warned of an unprecedented default and announced the suspension of all outstanding debt payments for an interim period in a bid to save dollar reserves for essential imports of food and fuel. Commodity exporters in emerging markets such as Iraq and Oman continued to benefit from higher commodity prices due to the Russian invasion of Ukraine and the associated impact on oil and gas supplies. in gas.

Portfolio Review

Over the period, the Fund outperformed the index by 205 basis points. The Fund’s shorter duration relative to the index, country selections and stock selections all contributed positively to performance, adding 91 basis points, 91 basis points and 23 basis points² respectively.

We maintained our underweight exposure to duration as we expected global bond yields to rise while credit spreads remain high. Our strategy continued to favor overweighting high yield issuers versus the investment grade sector, as the higher yield offered by this sector can offset some of the interest rate risk.

The main positive contributions came from our overweight positions in the United Arab Emirates and Qatar, which added 26 and 23 basis points respectively. With the Ukraine crisis lingering throughout the second quarter, Western sanctions against Russia intensified, with the EU announcing its plan to significantly reduce its dependence on Russian oil imports by the end of the year . We maintained an overweight exposure to net energy exporters as energy demand continues to outstrip supply and global inventories remain low. Our exposure to lower rated oil exporter Nigeria also contributed 22 basis points to performance. Other positive contributions came from Investment Grade issuers in the Latin America region, including Chile, Panama and Peru. In Peru, political noise waned following social protests against fuel, fertilizer and food price hikes in April and the approval of the pension fund withdrawal in May.

Conversely, the Fund’s underexposure to China hurt performance (-31 basis points). Amid the sell-off in risky assets, Chinese dollar government bonds only suffered a loss of 1.5% due to strong local demand for these bonds. As the Fund held an underweight position, its exposure to China was negative on a relative return basis. Additionally, our overweight positions in Colombia, Morocco and Senegal lagged. Colombia hurt Gustavo Petro’s victory in the presidential elections and markets were wary of the possibility that the new president, once sworn in on August 7, could adopt more radical proposals promised in his campaign, such as a ban oil exploration, surface mining and fracking.

During the period, we increased our exposure to high quality bonds to reflect the risk of an economic slowdown amid market concerns over the Fed’s aggressive policy tightening.

Note: Asset class representations are as follows: MLP, S&P MLP Index; high yield bonds, Bloomberg US Corporate High Yield Total Return Index; Emerging Market Bonds, Bloomberg EM USD Aggregate Total Return Index; corporate bonds, Bloomberg US Corporate Total Return Index; REIT, FTSE NAREIT All Equity REITS Index; stocks, S&P 500 index; and fixed rate prime rates, ICE BofA Fixed Rate Preferred Securities Index. Performance data quoted represents past performance and does not guarantee future results.

Outlook & Strategy

With both the war in Ukraine and growth uncertainties due to COVID-related restrictions in China continuing from the prior quarter, investors are still facing major headwinds when it comes to supply chain disruptions. supply and export of raw materials. In this context, global growth is declining and the risks of recession are increasing, while the threat of inflation remains. As the Fed continues to fight mounting inflationary pressures in the US by tightening monetary policy, the risk of selling pressures is high as investors look to hedge their positions. Although it appears markets have been pricing in a reasonably aggressive upward path for the Fed with at least another 150 basis points of rate hikes by the end of this year, neither the pace of inflation nor the risks of recession are unclear.³

Overall, we plan to maintain a more cautious stance as we expect the risk-reward mix to continue to tilt towards downside risks rather than upside potential. We plan to continue to elevate the credit quality spectrum by adding high quality issuers while reducing our lower quality and high beta exposures. We have a positive outlook on the higher quality corporate sector as it should provide better mitigation of downside growth risks given that credit fundamentals remain strong. Our regional allocation favors Latin America over regions in Asia and the Middle East, as rising commodity prices and hawkish central bank decisions in regional emerging markets may act as a buffer against a tightening of US monetary policy. From a country allocation perspective, we believe that credit differentiation against sovereigns with healthy external balance sheets will continue to be a major theme for emerging market assets.

Credit ratings shown are from Fitch, Moody’s and Standard & Poor’s. Ratings are measured on a scale that typically ranges from Aaa (highest) to D (lowest). If more than one of these rating agencies rated the security, an average of the ratings was taken to decide on the rating of the security.

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