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Emerging bond mix


By Margaret Schumacher                           

It is important to diversify your bond portfolio as much as it is important to diversify stocks.

From all points of view, I would include international bonds in a portfolio – and particularly emerging markets.

The emerging markets are countries where business activity and industrialization are advancing at a faster pace than in more established economies such as the United States and western Europe. Examples are Brazil, China, India and Indonesia.

If you look at the balance sheets of countries, the emerging markets have strengthened their balance sheets steadily over the past decade. 

One of the things that happened is that debt from emerging markets has become a safer investment now than it used to be, partially because of the higher rate of savings of individuals in the emerging markets. Also, these countries have learned how to be a part of the capitalist system in a way that they didn’t know earlier.

Although affected by the global recession, the emerging markets have been able to rebound faster without the financial fallout faced by more developed countries.  

Through the first half of 2010, the U.S. gross domestic product grew at an inflation-adjusted annual rate of 3%, compared with 3.7% in Germany and 1.7% in both England and France.  China’s economic output jumped 10.3% in the same period while Brazil and India both expanded 8.8%, and Taiwan advanced 12.5%.

Right now, you have to be aware of where you can get yield on bonds.

The longer-term U.S. government bonds, which make up the high end of the yield curve; those rates are dropping now. Currently, you can get a very low interest rate if you go with a U.S. Treasury.

But if you buy a bond in an emerging market, for that same maturity, I think you’re getting a much better yield, keeping in mind that you are taking on more risk.

Emerging market currencies can be very volatile, particularly in times of economic upheaval. But it looks like a good bet right now. If you believe the U.S. dollar is going to continue its long-term decline against some of these currencies, then you can try to get an additional return on that trend by holding some dollar-based bonds.

Investors today have a choice to buy these bonds in debt that is priced in U.S. dollars or that is priced in local currencies. Local currency bonds will give you performance more closely tied to the local economy.

You can own these bonds as part of your income allocation. They will not perform in lock step with the U.S. bond market. They are a non-correlated asset.

Margaret Schumacher is vice president at Landaas & Company.

initially posted September 10, 2010

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