The growth of the passive EM fixed income segment provides investors with powerful diversification tools which are well suited for risk diversification due to low correlations with developed markets and which have recently enhanced the yields of fixed income portfolios. Local currency EM sovereign debt has seen particular interest from investors in recent years, even though currency risks here are much more prevalent than with hard currency bonds.
UBS Asset Management has created an ETF that includes EM local currency sovereign bonds but compensates for potential liquidity shortfalls by making a partial allocation to short term USD denominated EM sovereign bonds. Based on the exchange rate fluctuations of EM currencies, an overlay is additionally used to go overweight or underweight according to carry and momentum factors, and the dollar component is converted into local currencies. The issue of this On Track focusses on the methodology that has created what we see as a best-in-class emerging markets local currency debt solution, with its unique construction methodology and intelligent use of FX factors.
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