9 December 2019
Heading into 2020, we continue to expect emerging market (EM) local currency debt to perform well relative to other strategies. With a potential phase one trade deal on the horizon, a mix of supportive factors could help to drive EM debt:
Of all of these factors, currency is most complex. Hedging EM currencies remains onerous as the short rate differential versus EUR remains quite high (4.1%).2 Logistically, over 50% of the index is only accessible via non-deliverable forwards, which need to be collateralized under EMIR regulation.
A weakening USD has historically led to flows into EM Debt. Moreover, in recent months market commentators have begun calling time on the era of USD strength. But a weaker USD potentially affects a EUR-based investor. For this reason, we believe investors could stand to benefit from hedging against a potential weakening of the USD versus the EUR while capturing the EM currency appreciation versus the USD.
The EUR-USD short rate differential is around 2.7%.3 Thinking in terms of insurance costs, this equates to a 0.23% monthly premium to hedge against a potential move of more than 5% in the EUR-USD pair. Based on the State Street Global Advisors currency valuation model, at 1.10 the EUR was c. 11% undervalued versus the USD on a long-term basis.
SPDR, in partnership with Bloomberg, has introduced a currency-hedging methodology new to the ETF market, which hedges only the USD base currency return of the index to EUR. As of 5 December 2019, the SPDR Bloomberg Barclays Emerging Markets Local Bond UCITS ETF is the only such ETF with this feature, allowing investors to harness the full potential of EM local currency debt in 2020.
Figure 1: Emerging Market ETF Weekly Flows - Global
Source: State Street Global Advisors, Bloomberg Finance L.P., as of 29 November 2019. Flows are weekly flows in EMD ETFs, hard currency and local currency in USD millions.
Source: Bloomberg Finance L.P., for the period 28 November – 5 December 2019. This information should not be considered a recommendation to invest in a particular sector or to buy or sell any security shown. It is not known whether the sectors or securities shown will be profitable in the future.
Source: State Street Global Advisors, Bloomberg Finance L.P., as of 29 November 2019. The share class currency for the unhedged fund is USD; the share class currency for the hedged fund is EUR.
Source: State Street Global Advisors, as at 30 September 2019. The fund performance inception date is 13 May 2011 while the performance inception date is 16 May 2011; this one-business-day difference reflects the lag between when the fund was first listed and when the first NAV was struck. Returns above are for the distributing, unhedged share class of the fund. The SPDR Bloomberg Barclays Emerging Markets Local Bond USD Base CCY Hdg to EUR UCITS ETF (Acc) is new and therefore does not have a performance history of its own. Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted. The contained performance data do not take account of the commissions and costs incurred on the issue and redemption, or purchases and sale, of units. Visit spdrs.com for most recent month-end performance. The performance figures contained herein are provided on a net of fees basis. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Performance returns for periods of less than one year are not annualised. Some of the products are not available to investors in certain jurisdictions. Please contact your relationship manager in regards to availability.
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Exp. Date: 31/01/2020
1Source: Bloomberg Finance L.P., 5 December 2019.
2Source: Bloomberg Finance L.P., 5 December 2019.
3Source: Bloomberg Finance L.P., 5 December 2019.