Wednesday, June 15, 2011

Inflation In Emerging Markets/Bought 50 ELD at 53.6 and 100 CEW at $23.23

Bill Gross maintains that the U.S. is in worse shape than Greece, when you add future liabilities to the existing debt and then compare the GDP to debt ratio.  Gross wonders who will be buying treasuries after the end of QE 2: CNBC Video The reference to the U.S. being in worse shape than Greece is made in the last minute of that interview. In his recent newsletter, he argues that the FED is engaging in "financial repression" by keeping rates artificially low: PIMCO  Among his suggestions for investors is to buy non-dollar denominated emerging market bonds, plus more floaters and fewer fixed rate coupon bonds.

Another interesting interview with Gross can be found at Morningstar, where he discusses better alternatives to owning U.S government debt. One of those alternatives is Canadian government debt.  I owned 400 shares of an ETF traded on the Toronto exchange that uses a ladder strategy to buy government debt issued by Canada and its provinces. Claymore 1-5 Year Laddered Government Bond ETF, CLF Fund Quote - (TOR) Dividends are paid monthly in CADs after the 15% withholding tax applied by the Canadian government. I own those shares as part of my Canadian Dollar (CAD) Strategy.  

The inflation rate in India rose to 9.06% in May, higher than the consensus estimate of 8.7%.  The Reserve Bank of India is scheduled to announce its next decision on interest rates on Thursday.  In May, the Reserve Bank increased its lending rate to banks to 7.25% from 6.75%, and is expected by many analysts to increase that rate by .25% on Thursday.  

Inflation in China increased to 5.5% in May, a 34 month high, and that country increased bank reserve requirements again in response. This latest increase was .5%.  The reserve ratio has been raised 6 times in 2011 and now stands at 21.5% for the largest banks.  The general idea is to withdraw credit availability by requiring the banks to hold more cash in reserve.  Retail sales rose 16.9% in May 2011, with industrial production up 13.3%, compared to May 2010.  

The market reacted positively to the news that growth in China had not slowed significantly yet in response to the efforts by the government to slow the inflation rate. I am not sure, by any means, that was the correct response.  The fact that inflation is increasing at alarming rates in emerging market nations will simply bring more measures to cool growth. As some have noted, including Roubini, those measures may eventually increase the possibility of a hard landing.  MSN Money

Since there is so much discord here at HQ about increasing the stock allocation, LB decided to increase the bond exposure on Tuesday, and to spread out the bond diversification by including more emerging market sovereign debt and currency exposure.

1. Bought 100 of the ETF CEW at $23.23 (see disclaimer):  I do recall buying this ETF.  Bought 50 Currency ETF for Emerging Markets-CEW at $20.25 I later sold those shares at $22:13 due to a lack of a dividend payment that year (December 2009):

I discuss in another post some of the reasons for buying this ETF and ETFs containing emerging market bonds: Stocks & Politics: Emerging Market Currencies and Bonds as Non-Correlated Asset Classes (May 2009 Post)

Generally, this particular asset class can cool down and dampen volatility in a portfolio which is one of my goals.  While there have been periods where emerging market currencies and bonds are positively correlated with U.S. bonds and stocks, usually at a low level, any asset correlation can change over time for various reasons, sometimes dramatically.   Instability & Volatility in Asset Correlations (May 2009 Post).  An investment advisor who believes in stability of correlations is in dire need of re-education.

This is a link to the sponsor's web page: Emerging Market Currency ETF | WisdomTree Dreyfus Emerging Currency Fund (CEW). The fund will equal weight a basket of currencies, rebalanced quarterly, which now include the Brazilian Real, Mexican Peso, Chilean Peso, South African Rand, Polish Zloty, Israeli Shekel, Turkish New Lira, Chinese Yuan, South Korean Won, Taiwanese Dollar and the Indian Rupee.  I have at times bought ETFs with exposure just to the Indian Rupee or the Brazilian Real.

The expense ratio is .55%.

The Funds FactSheet describes its goal and how it attempts to achieve it. I would not hazard a guess on how well the fund captures currency movements and money market rates in those foreign currencies through forward currency contracts.

The fund did pay out an annual distribution in 2010 of $.83916, consisting of .62769 in long term capital gains and .21147 in short term capital gains:  Distributions There was no "ordinary income" dividend paid in 2010. So, I do not know what the rate will be for this year until late December.

It is possible that emerging market bonds and currencies may further diversify a portfolio in the future with a negative correlation to U.S. stocks and bonds.  This may occur, by way of example, when and if investors lose confidence in the U.S. government's ability to manage its fiscal problems accompanied by overall slow to negligible GDP growth in the U.S.  If that occurs at a time of much better growth in emerging market countries, accompanied by relatively low GDP to government and private debt ratios compared to developed countries, then there could be a decoupling in correlation, where emerging market stocks, bonds and currencies have a negative correlation to U.S.D. priced securities, both in terms of the currency and the values of the securities in constant currency terms.  In other words, an asset class that goes up in value when another declines.

2. Bought 50 of the ETF ELD at 53.6 (see disclaimer): I have bought and sold several times ETFs and CEFs containing emerging market bonds. Prior to this purchase, I owned only 100 shares of the ETF, EMLC, devoted to this asset category:

This ETF does pay monthly dividends, always viewed as important, and I bought these shares back in September 2010. Bought 100 of the ETF EMLC at 26.18 (see Van Eck Global - Emerging Markets Local Currency Bond ETF (EMLC) and  Seeking Alpha article about its 2010 debut).  The local currency bond ETFs have explicit exposure to the potential currency risks and benefits. PIMCO | Investment Basics - Emerging Market Bonds (External and Local Markets)

I decided to buy ELD, rather than to add to EMLC, due to the different weightings of these two ETFs.  EMLC has the following weightings:

South Africa: 10.06%
Brazil: 9.99%
Mexico: 9.9%
Poland: 9.9%
Turkey: 9.4%
Malaysia: 9.15%
Thailand: 7.5%
Indonesia: 7.13%

The remainder is scattered in other countries like Peru, Chile, Egypt and Columbia.  The fund has 183 securities.  I just took that information from the sponsor's Fact Sheet for the 2011 1st quarter.

ELD gives me a slightly different tilt which may work out, or not,:

Brazil: 11.35%
Mexico: 11.17%
Malaysia: 11.09%
Indonesia: 10.34%
South Africa: 7.65%
Poland: 7.52%
South Korea: 7.47%
Turkey: 7.47%
Thailand 7.32%

WisdomTree - WisdomTree Emerging Markets Local Debt Fund (ELD)(as of 6/3/11) I receive more weight in Mexico and Brazil with ELD, two places mentioned by Bill Gross as alternatives to U.S. debt in the interviews cited above.  This fund has an expense ratio of .55% and has 92 holdings (68.52% sovereign bonds).

As noted in this article at Fidelity, there has been significant improvement in the credit quality of emerging market sovereign debt over the past several years.  This article from T. Rowe Price provides seven arguments for investing in emerging local currency bonds.

Before buying ELD, I also looked at the iShares JPMorgan USD Emerging Markets Bond Fund (EMB).  I preferred the country allocation of ELD.  The Ishares product has the largest allocation to the Russian Federation, which makes me nervous, and a significant allocation to Venezuela and Kazakhstan, making the OG even more anxious.  The expense ratio is .6% and distributions are made monthly.  As of 6/3/11, ELD had no exposure to Venezuela or Kazakhstan, and a 3.73% weighting in Russia.

I have traded some CEFs in the past that own emerging market bonds, such as ESD:

ESD 2009 Trade +191.97

Several of these CEFs can be found listed under the "World Income" section at the  Closed-End Funds by Category - Markets Data Center -  A listing can also be found at the CEFA - Closed-End Fund Association.

Others include two offerings from Morgan Stanley (EDD and MSD) and two from Western Asset (ESD) and (EMD).  All of those CEFs sell at a discount to NAV.   I elected to avoid ESD due to its exposure to Russia and Venezuela.   ESD Portfolio Details  The CEF EMD has the same issues for me:  EMD Porfolio Details  A lot of their emerging market bonds are denominated in U.S.Ds. (see ESD Annual Report filed with the  SEC)

I bought a couple of bonds on Tuesday that I will discuss in the next post. 


  1. Stagflation officially arrived. CPI 3.6% yoy, and Empire State manuf fell off a cliff. Watch Ind Prod @ 9:15. The corrupt BEA used a deflater of 1.8% to arrive at a positive GDP, using 3.6%, GDP has been contracting, negative 1% at least. QEIII can't be justified, the entire inventory build was Fed money injections and corrupt Gov subsidies.

  2. There goes the VIX.