Deutsche Asset Management has launched a quality-weighted fixed income ETF that provides exposure to emerging markets sovereign bonds. The db x-trackers iBoxx USD Emerging Sovereigns Quality Weighted UCITS ETF (DR) tracks a newly-developed benchmark - the Markit iBoxx USD Emerging Markets Sovereigns Quality Weighted Index - which re-weights emerging market countries within a benchmark using a quality-weighted methodology based on fundamental factors.
The new ETF has been listed on the London Stock Exchange (LSE) and Deutsche Börse and follows the December 2015 launch of Deutsche Asset Management's first strategic beta ETF tracking a quality-weighted Eurozone sovereign bonds index.
"The launch is a good example of our ambition to be at the forefront of product development in the smart beta and fixed income segments," said Martin Weithofer (pictured), Deutsche Asset Management's head of strategic beta. "We have developed a quantitative approach to make a quality assessment on EM countries. We use eight different macro-economic criteria such as inflation, per capita income, GDP growth rate, etc. and this provides us with a measure of the relative attractiveness of countries, and based on that information we look at sovereign bond benchmarks featuring those countries and we change the weightings of the single countries."
According to Weithofer, this is a very relevant element because in the fixed income segment there are issues around liquidity and tradability that are addressed by this index. "The resulting index is very close to the benchmark but with a strong focus on quality," said Weithofer, adding that traditional fixed income sovereign benchmarks by contrast typically weight constituents by market value of outstanding debt which can result in the most indebted countries having the highest weighting in the index.
Eligible bonds in the emerging markets quality-weighted index are selected in accordance with an adjustment methodology that grades sovereign issuers using a series of fundamental measures, such as global competitiveness and inflation rate, history of default, sovereign debt as a proportion of GDP and GDP growth rate. Countries that are currently over-weighted in the emerging markets quality-weighted index - relative to a traditional non-weighted emerging markets sovereign index - include the Philippines and Turkey. Countries that are currently under-weighted in the emerging markets quality-weighted index include Brazil and Venezuela. The annual yield of the index is 4.56%, with duration of 6.95 years (Source, Markit iBoxx, March 31, 2016). The ETF is physically replicated and has an annual all-in fee of 0.50% for the US dollar share class.
"The focus on quality is something that investors are demanding because that approach increases the liquidity of the underlying portfolio, and from a yield perspective the whole quality approach delivers returns in line with the broad markets," said Weithofer. "Many investors and managers get carried away by the prevalent emerging markets yields because they are inflated by astronomically high yields from distressed countries which have very little chance to materialize. We expect investors will appreciate that the yield of our approach is more transparent and more achievable."
The new index also reflects the drive towards the fixed income segment and how alternative weighting is also being applied in this space, said Weithofer. "We have seen a number of developments around smart beta in the equity segment but we are now seeing an increasing number of strategic beta strategies applied around the fixed income segment," he said. "There is a very strong demand from clients seeking to deploy strategic beta underlyings in their investment products, and we think this index will resonate with clients seeking alternative and cost-efficient exposure to EM sovereign bonds."
The index is targeted at institutional investors seeking to get exposure to emerging markets debt with a risk reduction in order to diversify their sources of yield, said Weithofer. "This kind of approach improves the risk profile of the underlying, and although it is transparent and easy to understand, we are talking about assets that require a degree of sophistication from the investor side," he said. "The index is suitable for any investment solution, including structured products, but we believe it's better suited for long-only directional investors."
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