While stock funds have plummeted and bounced during the last five years, bond funds, for the most part, have been steady gainers. Moreover, according to mutual fund tracker Morningstar Inc., no type of bond fund has even come close to emerging markets bond funds, which have posted an annualized return of more than 14.5% during the last five years. (U.S. intermediate-term government bonds, by comparison, have returned 6.4% per year in the last five years.)
Should you put your money into these funds? Perhaps. But first you need to know what you’re buying. Emerging markets, in the language of Wall Street, include just about every place except the U.S., Canada, Japan, Western Europe, Australia, and New Zealand. Some funds hold bonds issued in the undeveloped world, either by governments or local corporations. Recently, top holdings in emerging markets bond funds included issues from Brazil, Russia, Turkey, and Mexico.
“Many of these countries have had recent credit upgrades, indicating economic and political progress,” says Arijit Dutta, a mutual fund analyst at Chicago-based Morningstar. “Those upgrades have increased bond prices. In addition, investing in these bonds may help to diversify your fixed-income holdings. However, this can be an extremely volatile category, so the risks shouldn’t be ignored.” Higher risks may lead to higher yields, which is another attractive feature about these bonds.
If you’d like to invest in emerging markets bond funds, there are several ways to do so. “I suggest them to clients who have long-term horizons and can tolerate a sharp monthly drop without having heart palpitations,” says Tracy Brown, a financial adviser
with William Tell Financial Services in Latham, New York. “I might recommend that they put 5% to 10% of their bond allocation into these funds. Over time, emerging markets bond funds can add to your total returns.”Chris Dardaman, CEO of Polstra & Dardaman, a wealth management firm in suburban Atlanta, places a small portion of his clients’ assets in emerging markets bond funds because they “have a lower correlation to the U.S. interest rate cycle.” In 1999, for example, when U.S. government bond funds lost money, emerging markets bond funds gained 27%.
“This can be a tricky asset class,” says Dardaman, “so we invest through PIMCO Diversified Income (PDVAX), a multisector fund.” The PIMCO fund invests in U.S., foreign, and as well as emerging markets bonds, adjusting its allocation to each category as market conditions change.
“PIMCO Emerging Markets (PAEMX) and Fidelity New Markets Income (FNMIX) are my picks in this category,” says Dutta. “Both companies have the necessary depth in their research departments. When you invest in emerging markets, there are large differences from one country to another, and you have to be able to choose among them.” The expenses in this research-intensive category are considerably higher than those in most other bond fund categories. The Fidelity fund starts out with an advantage; its expense ratio is just under 1%.
Brown adds MFS Emerging Markets Debt (MEDAX) and Scudder Emerging Markets Income (SCEMX) to her list of favored funds in this category. “I like the way these funds spread the risk among different countries and different types of issuers,” she says. “The managers have experience in this asset class, too.”
Emerging markets bond funds have enjoyed six straight years of double-digit gains, from 1999 to 2004. But before the streak began, the category lost 22% in 1998, so there may be down years in the future. “After an extended rally,” says Dutta, “investors should be doubly cautious.”
Nevertheless, worldwide economic growth seems to be continuing, and developing countries rich in natural resources are benefiting from higher commodity prices. Long-term investors interested in diversifying their bond portfolios should consider emerging markets.
TOP EMERGING MARKETS BOND FUNDS RANKED BY 3-YEAR RETURN
| Name | Ticker | 1-Yr. Total Return* | 3-Yr. Annualized Total Return* | 5-Yr. Annualized Total Return* | Minimum Initial Purchase | Phone Number | Expense Ratio |
| AllianceBernstein Emerging Mkt Debt A | AGDAX | 19.83 | 22.95 | 16.16 | $2,500 | 800-227-4618 | 1.21 |
| PIMCO Emerging Markets Bond A | PAEMX | 21.76 | 20.50 | 18.95 | $5,000 | 888-877-4626 | 1.25 |
| TCW Galileo Emerging Markets Income I | TGEIX | 19.85 | 20.14 | 15.83 | $2,000 | 800-386-3829 | 1.20 |
| MFS Emerging Markets Debt A | MEDAX | 24.40 | 19.85 | 17.81 | $1,000 | 800-225-2606 | 1.41 |
| T. Rowe Price Emerging Markets Bond | PREMX | 25.83 | 19.69 | 14.98 | $2,500 | 800-638-5660 | 1.08 |
| Fidelity New Markets Income | FNMIX | 21.74 | 19.67 | 14.41 | $2,500 | 800-343-3548 | 0.94 |
| MainStay Global High Income A | MGHAX | 21.98 | 19.36 | 15.09 | $1,000 | 800-624-6782 | 1.53 |
| Fidelity Advisor Emerg Mkts Inc T | FAEMX | 21.77 | 19.11 | 13.86 | $2,500 | 877-208-0098 | 1.44 |
Source: Morningstar Inc.
Morningstar makes every effort to ensure the completeness and accuracy of this data but cannot guarantee it.
*Returns through June 30, 2005, DISTINCT SHARE CLASS, RETAIL ONLY