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Finding Hefty Yields in Emerging Markets Bonds

Tickers in this article: GSDAX TGEIX REBAX IHIAX
NEW YORK ( TheStreet) -- Emerging markets bond funds have been rallying. The funds returned 15.0% this year, outdoing the Barclays Capital Aggregate Bond (LAG) index by 11 percentage points, according to Morningstar. Investors have taken notice, pouring $19 billion into the funds this year, a huge inflow for a category with $73 billion total assets.

Can emerging bonds continue to deliver solid returns? Probably. The bonds pay compelling yields. At a time when 10-year Treasuries yield 1.65%, some emerging markets funds yield more than 5.0%. Besides paying rich yields, many countries in Latin America and Asia boast strong balance sheets. That has special appeal in an era when developed countries are plagued with huge debt burdens.

After struggling with financial crises in the 1990s, many emerging countries tightened their belts, reducing budget deficits and paying down debts. As a result, ratings agencies have upgraded many emerging countries, including Brazil, Turkey, and Russia, that were once considered below-investment grade. The upgrades have helped bond prices to rise sharply.

While the emerging markets improved their positions, the U.S. and Europe engaged in a borrowing binge. In response to the undisciplined actions, ratings agencies downgraded many developed countries, including the U.S., France, Ireland, and Austria, that once were considered AAA, the top debt rating.

Despite much talk about reform, debt positions of developed countries have continued deteriorating, says Dave Robbins, portfolio manager of TCW Emerging Markets Income (TGEIX) . At the start of the financial crisis in 2008, developed countries had debt levels that were equal to 80% of their gross domestic products. Since then the debt climbed to 110% of GDP. During the same period, the debt figure of developing countries declined from 35% to 34%.

The balance sheets of emerging markets will improve in coming years, Robbins says. With millions of consumers entering the urban middle classes in Asia and Latin America, the emerging economies should continue showing healthy growth and paying down debt. That should help to boost bond prices. The outlook is grimmer for the developed world, Robbins says. "In the next several years, there will be slow growth in the developed world because governments and consumers must repair their balance sheets," he says.

Funds that invest in emerging markets debt follow a variety of approaches. Some managers focus exclusively on bonds that that are denominated in dollars -- not in the currencies of the countries issuing the debt. Other funds emphasize bonds denominated in foreign currencies. In the past, many investors preferred the dollar bonds because they would not necessarily collapse if the foreign currencies fell. These days many investors favor local currency issues, which can strengthen as emerging markets grow.

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