Finding Jewels in Emerging Markets Bond Funds

NEW YORK (TheStreet) -- Worried about the uncertain economic outlook, investors have been dumping emerging market bonds and racing to buy Treasuries. During the past three months, emerging market bond funds have lost 3.4%, while long government funds have gained 19.8%, according to Morningstar.

But not all emerging bond funds have suffered equally. During the past three months, Fidelity New Markets Income (FNMIX) about broke even. The fund avoided trouble by following the cautious approach favored by portfolio manager John Carlson. The Fidelity manager shuns the lowest-quality bonds and emphasizes government securities that are issued in dollars -- not in foreign currencies. The dollar bonds often prove resilient in downturns. "Our first rule is to play good defense and avoid blowups," says Carlson.

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Is the recent turbulence a sign of trouble to come in the emerging markets? Probably not, says Carlson. He says that the emerging markets were pulled down by concerns about debt problems in Europe. But the panic has subsided, and the bonds have been recovering as global markets have rebounded. Now the bonds seem poised to deliver decent returns, he says. "The fundamentals of most emerging countries are in really good shape," he says.

Strong Growth

Fidelity and other emerging bond funds have attracted bigger followings lately. During the past year, investors poured $14 billion into the funds. That's a huge flood of cash for a category that only has $43 billion in total assets. Investors have been attracted by the improving outlook for emerging markets. At a time when the U.S. and Europe struggle with crushing debt burdens, many countries in Asia and Latin America have solid balance sheets and rapidly growing economies. As their prospects have improved, emerging market bonds have strengthened. During the past three years, emerging bond funds have returned 17.3% annually, ranking as the top-performing fixed-income category tracked by Morningstar.

Besides offering a chance to benefit from growing economies, emerging bonds also provide competitive yields. Emerging bond benchmarks yield around 6.0%, an attractive payout at a time when 10-year Treasuries yield 2.18%.

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