ETFs in EM local debt: Do they work?

T. Rowe Price
By September 6, 2021 08:34

ETFs in EM local debt: Do they work?

In recent years we’ve seen a surge of interest in exchange traded funds (ETFs) as a cost efficient and effective way to try and replicate market index performance. But are ETFs as effective as investors think? As part of our regular competitor analysis, we took a look at how leading ETFs in our asset class— emerging markets local currency sovereign bonds—had performed over the Covid crisis, and over the longer term.  

Replicating index performance in highly efficient markets, (e.g. US equities), is less challenging than it is in more complex asset classes. For example, emerging market ETFs may not be able to invest in all the securities that their benchmark does and some securities are subject to local market taxes that are not reflected in benchmark performance. ETF providers may need to rely more on derivatives to synthesise index performance. Derivative contracts cost money, and they don’t always perfectly track the underlying index components, especially at times of market volatility when trading conditions become difficult. 

We looked at the five largest EM local ETFs available to European investors. Since inception, their tracking errors versus their respective benchmarks ranged from 1.5% to 3% a year (0% would be a perfect replication). We also found that, without exception, all five ETFs’ price performance lagged the benchmark return. 

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Manon Savelkouls
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T. Rowe Price
By September 6, 2021 08:34

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