introduction to emerging markets inflation linked bonds

8/12/2019 Introduction to Emerging Markets Inflation Linked Bonds

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20thAnniversary

SPDR ETFs

What are Infation Linked Bonds?

A standard bond has three main elements:

Nominal- the xed initial investment amount

Coupon- the regular payments of interest which mustbe made

Maturity- the xed period of time until the debt mustbe repaid

Because with a standard bond, both the nominal and thecoupon are xed, the impact of ination can signicantlyaffect the return realised by the bond holder.

Ination linked bonds (or linkers) however, maintain thesame three elements (a nominal, a maturity and a coupon)but the nominal is no longer xed; it is linked to an indicatorof ination (e.g. the Consumer Prices Index or CPI) so thatthe coupon is applied to a proportionately larger or smallernominal, thereby adjusting the bond holders return andoffering some protection from the impact of ination.

Ination linked bond issuance has grown dramatically over thepast 30 years, with much of the initial issuance being drivenby the UK, and later, by the US. UK-issued linkers (indexlinked gilts) and US-issued linkers (Treasury Ination ProtectedSecurities, or TIPS) still make up a signicant proportion of themarket, but government issuers have diversied over time andin the past 10 years, emerging market governments have alsobegun to participate. Emerging market ination linked debt nowmakes up c.20% of the investable ination linked universe.

Introduction to Emerging Markets Infation Linked BondsJO MCCAFFREY, VICE PRESIDENT, SENIOR ETF PRODUCT SPECIALIST, STATE STREET GLOBAL ADVISORS

INFLATION IN THE EMERGING MARKETSAfter the crises that hit various emerging markets in the1990s (Mexico in 1994, Asia in 1997 and 1998) centralbanks began to adopt policies that aimed to make inationtargeting part of their standard, ongoing monetary policy.These, combined with increased independence for the majoremerging market central banks and broadly lower levels ofdomestic currency volatility have meant that emerging market

ination has generally trended downwards over the past10-15 years with fewer spikes of hyper-ination.

If we compare various emerging markets CPI data frombetween 1971 and 1998 with more recent data since theimplementation of these more adequate monetary policies,countries within the index show a clear trend towardsmore successful management of ination. This historicalimprovement is also reected in future projections, withEM ination rates expected to be approximately 4.5% forthe coming years; this compares with just below 2% for

most developed economies.1

Traditionally, two hallmarks of emerging market economies have been attractive growth opportunities and

concerns about ination. Accessing these growth opportunities is a well-worn path for most investors, with

emerging markets portfolios of varying sizes now commonplace for investors both large and small. Ination

however, has been harder to address directly for many investors within their emerging markets allocations,

with many using imperfect proxies, such as basic resources stocks, for ination protection. Now however,

investors concerned about ination have a new tool at their disposal in the form of emerging markets

ination linked bonds.

The SPDRBarclays EM Ination Linked Local Bond UCITS ETF is the rst ETF in the world to give investors

simple, diversied and transparent access to the global emerging markets ination linked bond market. In

one simple trade, investors are able to diversify their current emerging markets xed income allocation into

ination linked bonds issued by nine different emerging market governments. The ETF tracks the Barclays

Emerging Markets Ination Linked 20% Capped Index.

FIGURE 1: ESTIMATED SIZE OF GLOBAL INFLATION LINKED

BOND MARKETS

Emerging Markets $546b

Australia $27b

Canada $63b

France $244bGermany $73b

Italy $159b

Japan $41b

Sweden $36b

United Kingdom $546b

United States $845b

Source: Barclays as of 28 February 2013. Developed Markets indicates theBarclays Global Ination Linked Index and Emerging Markets indicates theBarclays Emerging Markets Global Ination Linked Bond (EMGILB) Index.


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THE DEVELOPMENT CYCLE OF EM BOND MARKETSWhen one considers the full range of emerging market debtthat exists today, a picture emerges of a fairly broad spectrumof issuance by both governments and companies. Issuancepatterns have tended to move in line with both marketcondence, and the nature of the issuer; government issues

precede companies, and in general, hard currency precedes local.

When market condence remains low, typically governmentsare only just beginning to issue debt and the bonds issuedtend to be in hard currency. As market condence growsover time, a subset of these countries mature and developsufciently to build a local currency bond market, representedby either nominal bonds, or for some, ination linked debt. Thegrowing market condence in the sovereign can also unlockthe capital markets for its domestic companies who, followingthe path of their government, issue initially in hard currencies.

We can therefore see the growth of emerging market inationlinked bonds as one step in the evolution of the broader emerging

market xed income landscape. For those more mature countriesthat have been able to capitalise on the momentum implied by theiremerging market nomenclature, they have proved able to movefrom hard currency to local, and issue in both nominals and linkers.

The development withinemerging market ination linkedbonds has also been signicant. As we saw earlier, in thepast, investors may have used investments in equities,commodities or property to try and offset inationary factorswithin their emerging markets allocations. Direct accessvia the more traditional route of ination-linked bonds wasimpossible due to limited issuance, prohibitive capital controlsand liquidity concerns. However, the market for emergingmarket linkers has grown strongly over the past 10 years, withthe number of issuers doubling and the number of issuesincreasing three-fold.2The total market now stands at almost$600bn, approximately the same size as the hard currencyemerging markets government universe, making it sufciently

diversied and liquid for an indexed investment approach.

This strong growth in issuance has attracted interest fromthe international investor base, but data issues and capitalcontrols mean that not all emerging market linker markets canbe accessed efciently. Columbian and Argentinian ination

linked debt, for example, are still subject to concerns aboutthe reliability of government-reported ination data, and theopenness of their markets for international investors. For thisreason, these two countries are usually removed from anyinvestable indices.

FIGURE 2: YEARLY CPI EVOLUTION IN %1971 TO 1998

Chile

Thailand

Poland

Israel

Mexico

S. Africa

Brazil Korea

Turkey

0

500

1000

1500

2000

2500

3000*

0

100

200

300

400

500

600

Jan

1970

1975 1980 1985 1990 1995 Jan

1997

Source: Bloomberg, as of 31 December 2012.* Secondary y-axis denotes CPI scale for Brazil

FIGURE 3: CPI EVOLUTION 1998 TO 2012

Jan

1998

2001 2004 2007 2010 Jan

20120

20

40

60

80

100

Chile

Thailand

Poland

Israel

Mexico

S. Africa

Brazil Korea

Turkey

Source: Bloomberg, as of 31 December 2012.

FIGURE 4. DEVELOPMENT CYCLE OF AN EM BOND MARKET

Increasing Market Confidence

IncreasingMarketConfidence

Hard Currency

Sovereign Bonds

Local Currency

Sovereign Bonds

Local Currency

Corporate Bonds

Hard Currency

Corporate Bonds

Local Currency

Inflation-Linked

Sovereign Bonds

Source: SSgA, as of 31 March 2013.

FIGURE 5: MARKET GROWTHEMERGING MARKETS INFLATION

LINKED BONDS

Brazil

Mexico

Argentina

S. Africa

Chile

Columbia

Poland

Turkey

S. Korea

Israel

Thailand

02004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Total Market Size (USD Billions)

600

500

400

300

200

100

Source: Barclays, as at 28 February 2013.


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ABOUT THE INDEXThe Barclays Emerging Markets Ination-Linked 20% Capped

Index measures the performance of ination linked bondsfrom nine emerging market countries in Latin America,EMEA and Asia. The index includes only government debti.e. direct obligations of the state issuer. Quasi-governmentand corporate debt are excluded. The index limits countryexposure to a maximum of 20% and redistributes the excessmarket value index-wide on a pro-rata basis.

Securities must be linked to a reliable measure of local-marketination that is not unduly revised or inaccurately reported by

domestic government agencies. This determination will bemade by the Index Sponsor in consultation with Barclays EMResearch and economics teams. This rule currently excludesArgentina from the list of eligible countries. Any countrywhere it is restrictively difcult and cost prohibitive for foreigninvestors to access the local markets will also be excludedfrom this list. This rule currently excludes Colombia.

FIGURE 6: HISTORICAL MONTHLY TOTAL RETURNS IN UNHEDGED USD,

2005YTD 2013

Local Currency

Unhedged in USD

Hedged in USD

%

-20

-10

0

10

20

30

40

2005 2006 2007 2008 2009 2010 2011 2012 YTD


Past performance is no guarantee of future results. It is not possible to invest directlyin an index. Index performance does not reect charges and expenses associatedwith the fund or brokerage commissions associated with buying and selling a fund.Index performance is not meant to represent that of any particular fund.

FIGURE 8: INDEX QUALITY BREAKDOWN

0

15

30

45

60

BBBBBAAA

Index Weight (%)


FIGURE 7: INDEX COUNTRY BREAKDOWN

0 5 10 15 20 25Thailand

Poland

South Korea

Chile

South Africa

Israel

Turkey

Brazil

Mexico

Index Weight (%)


FIGURE 9: INDEX MATURITY BREAKDOWN

0

5

10

15

20

25

30

>15 Yrs1015 Yrs710 Yrs57 Yrs35 Yrs13 Yrs

Index Weight (%)


Country, Quality and Maturity Breakdown data is as at the date indicated, is subjectto change and should not be relied upon as current thereafter


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WHY INVEST IN EMERGING MARKETSINFLATION LINKED BONDS?EXPANDS THE INVESTORS OPPORTUNITY SETThe SPDR Barclays EM Ination Linked Local Bond UCITSETF opens up a new segment of the emerging marketsbond universe for two different groups of investors: thoselooking to deepen and diversify their emerging market xedincome portfolios into ination linked bonds, away frompure nominals, and those investors who already havebroad ination-linked bond portfolios who are lookingto diversify into EM.

MAY PROVIDE SOME PROTECTION AGAINST INFLATIONInation can be partly driven by currency movements, soperiods of high ination are often accompanied by a rapidlydepreciating currency. In such a situation, a non-local investor

in emerging markets linkers may gain on one hand and loseon the other. Nonetheless, investing in emerging marketsination linked bonds may offer some protection againstmodest levels of ination within emerging markets, andwill give better protection than investing purely in nominalemerging market bonds.

ACCESS MORE MATURE EMERGING MARKETSThose emerging market governments that are able to issueination linked bonds in local currency tend to be moremature, having made the transition from hard currencyto local and from nominal bonds to linkers. This maturitymay suggest a more stable exposure than some of theless-developed emerging markets, whilst the decision

of a government to issue linkers may also suggest acommitment to controlling ination in their home markets.

WHY INVEST IN THE SPDR BARCLAYS EMINFLATION LINKED LOCAL BOND UCITS ETF? First ETF in the world to provide exposure to emerging

markets ination linked bonds.

SPDR ETFs have a proven track record at creating andmanaging best-in-class emerging market xed income ETFs:

SPDR Barclays Emerging Markets Local BondUCITS ETF the rst local currency emerging marketgovernment bond ETF in Europe. It offers investorsdiversied access to the onshore local currencygovernment debt of 19 markets.

SPDR Citi Asia Local Government Bond UCITS ETF the rst ETF in Europe to offer investors access to 8 Asian

local currency government bond markets, including China,through the use of CNH, or Dim Sum bonds.

SPDR BofA Merrill Lynch Emerging Markets

Corporate Bond UCITS ETF offers investors accessto a broad, diversied index of USD-denominated EMcorporate bonds.

Provides diversied, liquid access to a challenging emergingmarkets xed income exposure, in one simple trade.

Gives investors full transparency of holdings on a daily basis.

Allows for cost-efcient access to a traditionally expensive

area of xed income, where there are very few otherpassive alternatives.


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1 IMF World Economic Outlook Database, as of October 2012 http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/index.aspx.

2 Barclays as at 28 February 2013.


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