The Only Guide to Alternative Investments You'll Ever Need: The Good, the Flawed, the Bad, and the Ugly

Chapter 14. Emerging Market Bonds

During the 2000–2002 bear market for equities, emerging market bonds proved to be one of the top-performing asset classes. Although the global equities markets—including emerging market equities—suffered, many emerging market bond funds delivered double-digit returns, a trend that continued from 2003 through 2006. This led to a rush of investment dollars chasing the latest "hot" asset class.

Today, the question for prudent investors is whether emerging market bonds are an appropriate building block for a globally diversified portfolio. Or are investors experiencing just another case of "recency"—the tendency to assign too much importance to recent experience, while ignoring the lessons of long-term historical evidence? Let's examine the issues to consider to make the wisest decision.

Risks

Investing in international bonds exposes the investor to a mixture of risks that are different for each country. A country's unique set of risks (for example, political, economic, and cultural) make up what is collectively called its sovereign risk, the risk of a country defaulting on its debt. U.S. Treasury bonds entail no risk of default for U.S. investors. Default risk, however, is a real threat in emerging markets. Countries have defaulted on "foreign-denominated" debt, because of their inability to generate sufficient foreign currency to repay their obligations.

Because of these inherent risks, emerging market debt is a risky asset class, characterized by extreme ...