Emerging-Market Bond Funds Shine

NEW YORK (TheStreet) -The dollar has been sinking against many currencies from the emerging markets.

That is bad news for American tourists in Rio de Janeiro or Beijing who must pay more for hotel rooms and souvenirs. But the falling dollar has boosted the results for investors in a new breed of bond funds that hold emerging-market bonds that are issued in local currencies, such as the Mexican peso and the Indonesian rupiah.

Helped by the rising currencies, PIMCO Emerging Local Bond (PLBDX) returned 12.2% in the past year, 7 percentage points ahead of the Barclays Capital Aggregate Bond index, according to Morningstar.

Other funds that are boosted by rising foreign currencies include TCW Emerging Markets Local Currency Income (TGWIX) and WisdomTree Emerging Markets Local Debt ETF (ELD).

Because they can rise when dollar assets are sinking, the local currency funds offer intriguing vehicles for diversifying portfolios.

In the past, most emerging market bond funds were not designed to benefit from strengthening currencies. The funds traditionally invested mainly in government bonds that pay interest in dollars -- not in emerging market currencies. Investors preferred the dollar-denominated bonds because they worried that emerging-market currencies could collapse. When the Mexican peso and other currencies sank in the 1990s, the value of peso-denominated bonds dropped sharply for U.S. investors.

But in recent years, many emerging country currencies have been appreciating against the dollar. To take advantage of the changing environment, companies have been introducing local-currency funds.

Strengthening emerging currencies have given the local currency funds an advantage. During the past year, PIMCO Emerging Markets Bond (PEMDX), which holds dollar-denominated bonds, trailed PIMCO's local currency fund by 3 percentage points.

Emerging market bonds have been stars of the fixed-income markets. During the past decade, emerging market bond funds have returned 11.3% annually, ranking as the top performing fixed-income category. To capitalize on growing emerging markets, investors can buy either local-currency or dollar-based emerging bond funds.

But the local currency funds have an intriguing edge. Local currency bonds should outdo dollar-denominated issues in the next year, says David Robbins, portfolio manager of TCW Emerging Markets Local Currency and TCW Emerging Markets Income (TGEIX), which keeps most of its assets in dollar-denominated bonds. Robbins says that currency appreciation will help the local bonds.

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