The credit ratings of emerging countries improved along with their balance sheets. A decade ago, bonds from emerging economies were typically considered speculative issues with junk ratings. Since then, many bonds in the emerging markets benchmarks have been upgraded by Standard & Poor's to investment grade.
These benchmarks are now dominated by investment-grade issuers, including Russia, Mexico and Brazil. Many emerging-markets bond funds come with average credit qualities of BBB, the lowest investment-grade rating awarded by Standard & Poor's.
Improved credit quality has produced dramatic changes in the bond markets of these countries. Instead of appealing primarily to aggressive investors, the bonds attract bids from pensions and other conservative institutions that had previously avoided the risky issues. The institutions have helped to stabilize the markets and boost prices.
Have these bonds become too expensive in the wake of a long rally? Probably not. Many funds in the category yield more than 7%. That's an attractive payout at a time when 10-year Treasuries yield 3.5%.Emerging markets bond funds are sometimes compared to U.S. high-yield bonds, which are rated as junk. In fact, the emerging funds have proven less volatile because of their improved credit quality. While high-yield funds lost 26% in 2008, emerging funds dropped 18%. For a steady option, consider the MFS Emerging Markets Debt Fund (MEDAX). During the 10 years through July, the fund returned 15% annually, outdoing 92% of its competitors. Portfolio manager Matthew Ryan limited losses during 2008 by emphasizing bonds from stable investment-grade countries, including Chile and Panama. He steered away from shakier issuers, such as Pakistan and Ukraine.