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By Hal M. Bundrick



) -- Junk bond funds have been one of the few fixed income instruments to remain in the black so far this year, but those meager gains may be at risk. Continued defaults by emerging market (EM) issuers may impact the U.S. high yield market, according to Fitch Ratings.

"Default activity in July was notable in that it included dollar-denominated high yield bond defaults from two Mexican companies - Desarrolladora Homex (homebuilding) and Maxcom Telecomunicaciones," the ratings agency says in an analysis. "These joined defaults earlier in the year from another Mexican construction company, Urbi Desarrollos Urbanos, and telecommunication peer Axtel SAB."

Fitch reports that even though defaults remain low overall, the emerging market related default total of $2.8 billion through July is already the highest since 2009. The year-to-date default rate for this group is 2.5% versus 0.8% for the rest of the market.

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"Emerging market issuer defaults could contribute more meaningfully to U.S. high yield default trends if EM growth sputters as a consequence of the Federal Reserve's plan to scale back monetary stimulus," say Fitch analysts Mariarosa Verde and Eric Rosenthal.

EM dollar denominated issues total $116.5 billion, or close to 10% of U.S. high yield market volume and is comprised of some large issuers that are in distress, including Brazilian oil company OGX (Issuer Default Rating CCC, Negative Outlook, $3.6 billion in bonds). Of the $116.5 billion issues, an estimated $95.2 billion is unsecured.

Emerging market debt totaled only $65 billion at the end of 2010 with $43.3 billion issued since January 2012.

The largest country concentration in this group is Brazil ($30 billion), followed by Mexico ($16.3 billion) and China ($14.4 billion). Most of the issues are infrastructure-related and financial bonds. The top sectors include energy ($27.7 billion), banking and finance ($18.0 billion), telecommunication ($11.2 billion), real estate ($11.1 billion) and building and materials ($8.5 billion). The cyclical nature of the industry mix adds to their vulnerability if growth stalls, according to Fitch.

High yield default rates are already edging up as the trailing 12-month default rate rose to 1.9% in July from 1.7% in June. Four issuers defaulted on $3.0 billion in bonds, bringing the year-to-date volume tally to $11.4 billion and the defaulted issuer count to 23 -- versus $10.2 billion and 20 issuers in the first seven months of 2012.

Investors have yanked over $7 billion from high yield bond funds so far this year, according to Lipper.

--Written by Hal M. Bundrick for MainStreet