Could You Get More Out of Your Bond Portfolio?

Regional diversification is just as important for fixed-income funds as it is for the equity funds in a portfolio. By holding fixed-income instruments from around the globe, a portfolio could benefit from foreign currency appreciation, higher yields (particularly from fast-growing emerging markets), and less direct exposure to U.S. interest rates. Of course, there are trade-offs. Currencies can also depreciate. Non-U.S. interest rates fluctuate, too, sometimes adversely affecting international bonds. And emerging-markets bond funds have been quite volatile over time, reflecting the risk associated with some markets' lower credit standings. But over the long term we think a more-balanced portfolio makes sense in a world that is becoming increasingly global. Also, importantly, it gives investors exposure to some interesting (and profitable) opportunities, while at times smoothing out overall returns thanks to varying economic and interest-rate cycles.

Take emerging markets, for example. While emerging-markets bond funds are currently sporting impressive performance records and could thus be due for a breather--and when they fall, the tend to fall hard--many global-bond portfolio managers argue that emerging markets are becoming more-attractive places to invest for the long haul. Generally speaking, many of these developing countries are becoming less reliant on external capital flows to finance growth, which is a result of stronger economic and political institutions as well as lower debt and inflation. As a result, some countries' sovereign debt boasts investment-grade status--Brazil's being the most recent to be upgraded by Standard & Poor's in April 2008. Meanwhile, some emerging markets continue to grow at a clip much faster than those of the U.S. and other developed markets.

The best options for global fixed-income exposure are our handful of  world-bond and  emerging-markets bond Analyst Picks, but the  Premium Fund Screener is a great way to cast a wider net for world-bond and emerging-markets bond funds. First, we limited the screen to reasonably priced world-bond and emerging-markets bond funds that require $10,000 or less as an initial investment. While we normally screen for solid 10-year performance records, the very limited number of such funds that have been around that long caused us to adjust our screen: We required a top-third finish versus the category average for the past five years. Before revealing our results, keep in mind that as emerging-markets bonds have rallied recently, many of these funds had a big tail wind. Like stocks, bonds can move in cycles as investor risk appetites, economics, and valuations change, so investors here should maintain a long-term investment horizon and keep their expectations in check, particularly over the short term.

As of May 7, 2008, the Premium screener pulled these funds:

World Bond
 AllianceBernstein Global Bond (ANAGX)
 American Funds Capital World Bond (CWBFX)
 T. Rowe Price International Bond (RPIBX)
 Templeton Global Bond (TPINX)

Emerging Markets Bond
 DWS Emerging Markets Fixed Income (SCEMX)
 Fidelity New Markets Income (FNMIX)
 MFS Emerging Markets Debt (MEDAX)
 T. Rowe Price Emerging Markets Bond (PREMX)

Among the world-bond funds, Morningstar analysts have long been fans of  Templeton Global Bond (TPINX). While the dollar has sagged and interest rates have declined, this fund has averaged a whopping 11.6% per year for the past five years. Manager Michael Hasenstab leads the way here, and he and his team generally look for high-quality foreign-government debt. Hasenstab has molded a distinctive portfolio compared with the fund's benchmark, the Citigroup World Government Bond Index, in part due to his willingness to scoop up emerging-markets bonds that he finds undervalued. Although it's more volatile than the typical peer, this fund has delivered the goods during Hasenstab's seven-plus-year tenure.

On the emerging-markets bond front, DWS  Emerging Markets Fixed Income (SCEMX) is an interesting choice for even bolder investors. Managers Brett Diment, Edwin Gutierrez, and Nima Tayebi run the show here. Over the past year, returns have slowed due to a large allocation to Turkey, which has a large current account deficit, as well as to politically riskier areas such as Venezuela and Argentina. That said, the managers also invest in issues from Brazil and Mexico. These countries tend to be favored by other managers in this category because of the stability that has come from soaring energy prices in addition to the relative strength of those countries' economic and political institutions. In the end, we think the managers' bolder approach may help diversify a portfolio.

Morningstar.com Premium Members can run this screen themselves by  clicking here. Not a Premium Member? You can still run this screen by taking a free, 14-day Premium Membership trial. (Note that the results may change as funds come in or drop out of the screen over time.)