ETF Expert

Demand for foreign bonds in foreign currencies have obliterated analyst expectations. For instance, Wisdom Tree Emerging Market Local Debt (ELD) swelled to nearly $1 billion in net assets in 9 months time. By way of comparison, the dollar-denominated PowerShares Emerging Market Sovereign Debt Fund (PCY) began nearly 3+ years before ELD, though both PCY and ELD have roughly the same amount under management.

Not anymore.

On the last day of May, institutional block seller(s) dumped $150 million worth of ELD on more than 10x the normal trading volume. In a blink a the bull’s eye, 15% of ELD’s assets under management disappeared.

The timing is particularly intriguing. Why now?

Does an influential adviser believe that emerging markets have not yet begun to fight the inflation battle, such that interest rates by central banks will be rising for 6-12 months or longer? Ongoing rate hikes in Latin America and Asia would certainly take the wind out of the foreign income sails; however, currency gains might offset some of the price depreciation. It follows that I don’t believe that the decision to shed ELD came as a result of rate hike fears. 

Might an influential person or persons see a dollar reversal on the horizon? If so, extraordinary gains in the U.S. dollar would certainly harm foreign bonds that are priced in foreign currencies. Still, even if a near-term dollar reversal came about due to ongoing Eurozone troubles, I wouldn’t bank on a long-term strengthening of the buck. Remember, the Fed is likely to introduce ”QE2 Lite,” effectively diminishing long-term desire for U.S. dollars.

Could an active trader have moved to lock in gains at month’s end? Perhaps. Just as some advisers will buy “hot” investments at the end of a month to dress up a portfolio for statement viewing (i.e., “window dressing,”), others will undress the windows to show that they are raising cash reserves in challenging times.

While I can’t possibly know the answer, I am extremely curious. Wisdom Tree Emerging Market Local Debt (ELD) isn’t a trading tool like leveraged stock and commodity vehicles; primarily, ELD offers a non-correlating asset for portfolio diversification. You know… “seeking alpha.”

In my estimation, ELD is worthy of holding for now. It’s less than 1% off 52-week highs and well-above technical moving averages.

Granted, the dollar could strengthen. Emerging market inflation could quicken. And the 4.4% achieved in the first 5 months of 2011 could erode. Nevertheless, the 5% annualized income stream (delivered monthly) is plenty desirable for those that have enough exposure to stocks and commodities.

Keep in mind, the average yield to maturity in ELD is 6 years. As long as a fund like iShares Barclays 3-7 Treasury Bond (IEI) yields a paltry 2%, one should expect investor demand for higher total return. ELD provides higher total return through higher interest payments as well as the potential for currency-driven capital appreciation.

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