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By Paul Justice, CFA | 06-15-2011 03:32 PM

Emerging-Markets Debt Gets Respect

WisdomTree CEO Jonathan Steinberg thinks that investors are becoming more interested in emerging-markets sovereign debt because those nations are displaying better fiscal discipline than developed countries.

Paul Justice: Hi there. I am Paul Justice for Morningstar. Today, I'm joined by Jonathan Steinberg, CEO of WisdomTree Investments. Jonathan, thank you for joining me.

Jonathan Steinberg: Thank you.

Justice: I think that one of the most interesting asset classes that's really been brought into the conversation recently is emerging-markets debt or foreign debt exposure for U.S.-based investors. Most investors at this point have accepted emerging-markets equities as an asset class, but we see strong growth in these areas. Could you talk a little bit about how you're addressing that portion of the market right now?

Steinberg: In the last eight months, we've launched two emerging-markets local debt funds; one is Emerging Markets Local Debt, ticker ELD, and the other is Asian Local Debt, ticker ALD, both giving you the currency exposure. And I think the appeal is that, one, it is very hard to obtain access to these asset classes using traditional structures. There haven't been that many choices out there. But in this very low U.S. interest-rate environment, people are searching for additional yield, and these funds have typically higher yields. Ours are sovereign-debt-based, so there is inherent safety into the portfolios. Diversifying your portfolio with higher yields and higher credit quality, really has been something that people have very quickly embraced.

Then the emerging markets in general have been showing sort of a greater fiscal discipline than during historical times relative to the developed world. So, there's just a strength to these portfolios that historically might not have existed.

Justice: Certainly. Ten years ago if you would have told me to buy emerging-markets debt, I would have thought you were crazy, but we've seen the paradigm shift. Many of these countries are now the lenders to the developed world and have a very strong monetary system in place.

Steinberg: Exactly, and they're showing on a day-to-day basis, fiscal discipline. They're running at surpluses in many cases. They're raising rates if they're feeling inflation is a threat. They're making hard choices. In some cases, the comparison versus the developed world is striking, and the emerging markets are looking better and better.

Justice: So, these are going to be a bit more volatile than, say, local debt, and merely because of the currency exposure. But many investors are courting that these days in fears of maybe a weak dollar or the emergence of the emerging markets.

Steinberg: Yes, and in fact, almost all of your equity exposures, when you're investing internationally, has the currency exposure, as well. So, this is sort of the mainstream way to invest in foreign debt, though away from WisdomTree, there had been some emerging-markets debt that had been issued in dollars. But we don't think that's most people's primary way for access to this if they could choose otherwise.

Justice: Now, let's talk about some of the methodology in the bond selection in these funds. Is this purely going after the biggest debtor countries?

Steinberg: No. So, they are not cap-weighted. I wouldn't call it fundamentally weighted. But we use our active exemption, and we're using sort of a fundamental within the different country weights. We're breaking up the countries into tiers by credit quality and fiscal stability. So, we have our top tiers that would get the highest weights, and you would equally weight the different countries within each tier. And you end up with a broad-based balanced portfolio.

We're trying to put a risk metric in there, so that we're constantly monitoring for events to just hedge the downside, which could be viewed when you're cap-weighting your bond funds. In many cases, you are overweighting to the biggest debtors, and again, like in equities, that really doesn't seem to make sense to us. And it doesn't seem to make sense to investors. In fact, ELD and ALD have been the fastest-growing funds that I think WisdomTree has ever launched.

Justice: So, you've got emerging-markets exposure, income generation, and some quality governors on the ends here of the fund?

Steinberg: Yes, I think that is a very succinct way to say it.

Justice: Great. Well, we do own ELD in our model portfolios in the ETFInvestor newsletter. So, we definitely see its merits.

Steinberg: Thank you.

Justice: Thank you for joining us. I'm Paul Justice for Morningstar. For this and other ETF information, please check out Morningstar.com or our ETFInvestor Newsletter.

 

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