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An emerging alternative to low yields

Government bonds in developing countries offer high payouts - and credit quality that has been steadily improving


Searching for an alternative to the pitifully low yields available in the Canadian market? Look no further than Indonesian bonds.

A typical 10-year Indonesian government bond is now yielding more than 5 per cent a year. And, at least in the eyes of credit rater Moody's Investor Services, it is now an investment-grade credit, with relatively low risk of default.

As Indonesia demonstrates, the government bonds of many emerging markets now offer a tempting mix of high yields and reasonable credit quality. Brazil and Peru were upgraded to investment-grade ratings in 2008; Indonesia joined the club just this month.

Among advanced nations, the trend is heading in the opposite direction. While still regarded as investment-grade quality, countries such as France, Austria and the United States have lost their coveted triple A-ratings over the past year. The debts of euro-zone nations such as Greece, Portugal and Ireland have plunged to "junk" status, denoting a rising probability of default.

"Emerging market bonds really demand a second look for the remainder of this decade," suggests Peter Marber, chief business strategist of emerging markets for HSBC Global Asset Management (USA) Inc. "We are starting to see credit convergence. ... About two thirds of the emerging market countries are already investment grade."

The idea of investing in emerging market debt is still relatively new in Canada, where the oldest mutual funds or exchange-traded funds that dabble in the area date back only to 2010. Still, analysts say there is a case for this asset class given the improving credit quality of developing nations, the higher yields of their bonds, and potential returns from currency appreciation.

Many developing nations now have a lower ratio of government debt to gross domestic product than some advanced countries. The International Monetary Fund estimates that the average debt-to-GDP ratio in the advanced nations will be around 131 per cent this year versus 35 per cent for developing countries.

Investors have paid a great deal of attention to emerging-market stocks given the surging economies of developing nations such as China and Brazil, but "debt is actually is the most interesting way to play [emerging market growth]," said Mr. Marber, a veteran bond manager and author of books such as From Third World to World Class and Seeing The Elephant: Understanding Globalization from Trunk to Tail.

Emerging market debt was the bad boy of the bond world after the Asian currency crisis and Russia's debt default in the 1990s. But over the past 12 years, emerging-markets bonds have outperformed emerging-market equities and North American debt, Mr. Marber said.

Emerging market bonds have done well because of the robust payouts they offer investors. Many now yield in the 6-per-cent range. But investors should make sure they are being adequately compensated for political risks, said Sergei Strigo, the London-based head of emerging-market debt and currency at Amundi Asset Management.

"Over the last year, you have seen a lot of political unrest in some of the Middle Eastern and north African countries," while Hungary's debt was recently downgraded to junk status after the country refused to budge on its decision to limit the independence of its central bank, he said.

Of course, there is also potential for higher returns because of currency appreciation when buying local currency debt, added Mr. Strigo, who runs two Excel emerging-market debt funds sold in Canada. "We like the Mexican peso. We think it is very undervalued, and think it is going to appreciate going forward, especially, if the growth in the United States is going to pick up later this year."

Despite attractive yields on emerging market debt, "I don't think it is for everybody," said Dan Hallett, a fund analyst with HighView Financial Group.

"The higher yield ... has been priced by the global bond market for a reason," he said. "You are not going to get 6-per-cent yield without some additional risks relative to investing in Canadian bonds."



Emerging market debt offers improving credit quality, strong long-term performance, higher yields and potential returns from currency appreciation. Here are ways to invest in the asset class:

FundMER1-yearreturn(to Dec. 31/11)
AGF Emerging Markets Bond1.93-0.20%
Invesco Emerging Markets Debt*n/an/a
Manulife Emerging Markets Debt*n/an/a
iShares JPM USD EM Bond CAD Hedged ETF*0.72n/a
HSBC Emerging Markets Debt Fund-I*n/an/a
RBC Emerging Markets Bond An/a7.74%
BMO Emerging Markets Bond Index ETF0.547.12%
Excel EM Capital Income2.532.73%
Excel EM High Income2.163.63%

*Funds with less than a one-year track record.

Source: Globe Investor, companies



In bond markets, where

"A" ratings denote higher-quality borrowers, many emerging markets now carry higher ratings than their developed counterparts.Emerging markets:

Chile AA

Brazil A-

Malaysia A

Developed countries:

Italy BBB+

Ireland BBB+

Portugal BB

Source: Standard & Poor's

© 2007 The Globe and Mail. All rights reserved.

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