All Emerging Markets Are Not Created Equal, Part 2
Our recent post on the WisdomTree blog discussed the role fundamentals play in our local currency debt investment process. As an example, we noted two ratings agencies’ negative outlook for Hungary and our decision over the past two years to exclude their debt from our portfolios. Conversely, the Philippines, a country we have owned in both of our local debt Funds since their inception, was recently upgraded by Fitch to investment-grade status for the first time in its history.1 On the same day, Standard & Poor’s upgraded Turkey’s local currency debt (which we also own) to BBB (the second-lowest investment-grade rating).2 As a result of the Philippines upgrade, all the countries in the WisdomTree Emerging Markets Local Debt Fund (ELD) and the WisdomTree Asia Local Debt Fund (ALD) now carry an investment-grade rating by at least one ratings agency for the first time since their inception.
While this represents an important milestone for the Philippines, we believe it also serves as positive reinforcement for our focus on fundamentals when investing in emerging markets. In uncertain or developing markets, biasing a portfolio toward stronger economic fundamentals could be a prudent way of reducing risk. In its report, Fitch noted that the impressive gross domestic product (GDP) growth of 6.6% in 20123 and a projected expansion of 5.5% in 20134 make the economy all the more attractive, given its comparatively low debt burden. Standard and Poor’s raised the outlook on the Philippines to positive near the end of 2012, noting policy momentum from President Benigno Aquino.5
Should S&P (or any other ratings agency) match Fitch’s recent upgrade, a whole new subset of investors could have the flexibility to allocate to the country’s debt.6 This has the potential to strengthen the Philippine peso against the U.S. dollar and at the same time increase bond prices. While the ratings upgrade is a clear positive highlighting that the Philippines is progressing in the right direction, this news still needs to be put in perspective. Emerging markets are not without risks, and there will undoubtedly be bumps along the way. However, the flexibility that active management provides gives the Fund’s Strategy Committee the ability to reduce or eliminate positions from the portfolio, should the unexpected occur.
Ultimately, we are heartened by the progress being made in many emerging market countries. As investors continue to look for higher yield potential globally, we believe interest in the asset class could continue to grow in the coming years.
1Fitch, March 27, 2013.
2Standard & Poor’s, March 27, 2013.
3International Monetary Fund (IMF), 2013.
5Standard & Poor’s, 2012.
6Some investors/indexes require a minimum ratings threshold for a security to be included in certain accounts.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions.
Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. In addition, when interest rates fall, income may decline. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Unlike typical exchange-traded funds, there is no index that the Fund attempts to track or replicate. Thus, the ability of the Fund to achieve its objective will depend on the effectiveness of the portfolio manager. Due to the investment strategy of this Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
S&P and Fitch ratings assist investors by evaluating the credit worthiness of many bond issues. AAA to BBB ratings are typically issued to those securities considered investment grade. The rating is not a recommendation to buy or sell a particular bond. For information on the rating agencies methodologies go to: http://www.standardandpoors.com/home/en/us for S&P and http://www.fitchratings.com for Fitch.