Bond ETF Investors Gain Access to Middle East

Most of the money in emerging market bond passive mutual index funds and ETFs is linked to JP Morgan benchmarks, meaning the inclusion of the Gulf nations has impact

Jose Garcia Zarate 18 October, 2018 | 7:15AM
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Jose Garcia-Zarate: JP Morgan has announced plans to include Saudi Arabia, Kuwait, Qatar, United Arab Emirates and Bahrain – all members of the Gulf Co-operation Council (GCC) – in its flagship emerging market debt indices starting from January 2019. This will cover conventional bonds and sukuk, or Islamic, bonds.

Historically, these countries had not qualified for inclusion in the JP Morgan indices due to their high levels of income per head, as well as, with the exception of Bahrain, their highly-rated sovereign debt. However, most investors would agree that these countries share many characteristics with emerging market economies.

To make them eligible for inclusion, JP Morgan has introduced the purchasing power parity ratio as a new parameter. Countries with a ratio below 60% will now qualify as emerging market, even if they don’t meet the other criteria. This new criterion adds flexibility in the selection process, but by the same token, it also makes it more difficult for countries already in the emerging market index to be upgraded to developed market status.  

The inclusion of the GCC countries will be done in monthly stages through to September 2019, with up to a 2% weighting added each month. By the end of the process, the combined weight of these countries is estimated to be between 10-12% of the index.  This will significantly boost the representation of the Middle East region in the benchmark and will also require the index to redistribute the weighting of other regions.

Most of the money in emerging market bond passive mutual index funds and ETFs is linked to JP Morgan benchmarks. Also, these are the indices of reference for the vast majority of active funds in this space. So, we should expect a comprehensive reconstitution of portfolios in 2019.      

Overall, the inclusion of the GCC countries is a welcome development. Over the past decade, these countries have become very active issuers in international government bond markets, as they try to diversify their economies away from a heavy reliance on fossil fuels. In fact, 2016 and 2017 were record-high years for bond issuance.

This will make the JP Morgan indices more representative of the emerging market universe; it will also increase its overall credit quality, as most of the new entrants have sovereign ratings of A or above, and potentially decrease volatility.

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Jose Garcia Zarate

Jose Garcia Zarate  is Associate Director of Passive Strategies Research for Morningstar Europe

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