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Finding Jewels in Emerging Markets Bond Funds

Cirmani says that in coming years the emerging economies are likely to grow faster than the U.S. That should enable the local currencies to strengthen against the dollar. "The emerging markets will continue to have an edge," he says.

Should you buy a local-currency fund or one that holds dollar bonds? That depends on your view on the dollar and you appetite for risk. Dollar bears might prefer a local-currency fund. But to build a diversified portfolio, consider holding two funds, one specializing in dollar bonds and a second that focuses on local-currency issues.

Another approach is to buy a fund that owns both kinds of bonds. A fund that holds a mix is Payden Emerging Markets Bond (PYEMX). During the past five years, the fund has returned 7.6% annually, outdoing 56% of competitors.

The fund holds both local-currency and dollar bonds from Indonesia, says Payden strategist Arthur Hovsepian. The bonds are rated BB, one step below investment grade, but the outlook is improving. The country is on the path to winning an investment-grade rating. That should help to boost the bond prices.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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