Time to Consider Emerging Market Bonds?

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During the first quarter of 2008, bond markets went haywire. With investors increasingly worried about defaults, the average high-yield corporate-bond fund lost 3.6%, according to Morningstar.

 

Even supposedly safe ultra-short-term bond funds lost 1.9%. In all the turmoil, emerging-market bond funds remained surprisingly stable. This represented a big change from earlier times when bonds from the emerging markets—such as Brazil and Thailand—routinely cratered at the first sign of trouble in the global economy.

 

The strong showing can be attributed to the remarkable changes that have been sweeping through the developing world. A decade ago, most emerging markets suffered from shaky finances, and many countries were burdened by large debts to foreign lenders. After Asian financial institutions started failing in 1998, emerging market bond funds lost 25.6% in one year.

 

But since then, many governments have tightened their belts. Countries in Latin America and Asia have cut government spending and begun accumulating reserves of foreign currencies. The big rally in prices of oil and other commodities has also provided a boost for countries such as Mexico and Chile, which have seen the value of their exports skyrocket. 

 

With their financial houses in better order, many countries have received higher credit ratings. While bonds from Brazil and Russia were once considered junk, both countries are now rated as investment grade by Standard & Poor's. Since the risk of default has declined, prices of emerging market bonds have been climbing. During the past five years, the average emerging market bond fund has returned 11.8% annually, ranking ahead of any other bond category.

 

To be sure, emerging market bonds come with risk, but many investors may want to consider owning a small stake. By investing in an emerging market fund, you may boost the yield of your bond portfolio and diversify holdings. A solid choice is Fidelity New Markets income, which holds government bonds from Russia and Mexico.

 

For a small position in the emerging markets, consider Loomis Sayles Bond. Though it keeps most of its assets in investment-grade U.S. issues, the fund often has about 5% of assets in emerging markets, such as Mexico and Thailand.

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