With Treasurys at an all-time low, financial advisors are seeking yield on risky ground abroad.
"What helps bolster the overall portfolio of any client in this low interest-rate environment where Treasurys aren't returning much is the increased yield in emerging market debt (EMD) and higher total returns in the overall EMD category," said financial advisor Sean Dowling.
Year-to-date through September 30, 2012, the emerging market debt ETF category has returned 14 percent compared with 8 percent in 2011 and 2 percent in 2008, according to iShares JP Morgan data.
"I am pleasantly surprised that EMD products have improved. They have liquidity, a reasonable expense ratio and hold a diverse basket of debt that help to reduce overall default risk within the ETF," Dowling said in an interview.
Out of 25 strategies, the Stamford, Conn.-based Dowling Group Wealth Management's current highest allocation is 11 percent in emerging market debt compared with only 4 percent just six months ago.
"The ETF is the best way for us to invest tactically in emerging market debt because we don't have to worry about a mutual fund manager making an arbitrary decision that could affect our strategy. We can increase and decrease our allocations as the market dictates," said Dowling, who began accessing investment returns in emerging markets with Powershare ETFs in 2007. He has since switched to JP Morgan iShares' dollar-denominated emerging market bond ETF.
"You have country and political risk in foreign markets, especially in emerging markets, but through these new and improved ETFs you're getting more exposure across many countries in a liquid vehicle," said Dowling.
But not all financial advisors are opting for ETFs as the best vehicle to invest in emerging market debt.
"I prefer mutual funds to ETFs because of the many risk factors that come into play within the space, which include interest rate risk, credit risk, taxation, inflation and currency," said Buff Dormeier, financial advisor and investment officer with Wells Fargo Advisors in Fort Wayne, Ind. "Given that ETFs typically invest in a static index benchmark, they don't have the ability to change their portfolio based on these underlying risks but mutual funds are actively managed and adjusted according to these risk factors."
The primary difference between ETFs and mutual funds in the EMD space is whether an advisor wants passive management (ETF) or active management (mutual funds) of a bond portfolio. That difference may soon disappear as more actively managed ETFs enter the market.