Morningstar's Favorite International-Bond Funds

Note: This article is part of Morningstar's May 2015 International Investing Week special report.

World-bond and emerging-markets-bond funds are often considered niche investment categories, but they've been getting mainstream attention in recent years.

Owing to an idiosyncratic strategy and standout performance,

. In all,

, raking in $4 billion during the month and more than $20 billion over the past year.

Meanwhile, investor interest in emerging-markets bonds has waxed and waned. The category has lost assets in the past year, but with $77 billion in total assets, it's still nearly four times larger than it was in mid-2008.

At the same time, foreign bonds are an increasing presence in many general bond funds. The median intermediate-term bond fund recently had 8% of its assets in non-U.S. bonds; the median fund in the multisector- and non-traditional-bond categories had 19% and 14%, respectively, in non-U.S. bonds as of their most recently available portfolios. That underscores the importance of checking up on your existing holdings' foreign-bond exposure before adding a dedicated vehicle.

And because the world-bond and emerging-markets-bond categories encompass such disparate strategies--ranging from fully hedged developed-markets-centric funds like the Vanguard offering to more exotic options featuring emerging-markets local-currency and corporate-bond exposure--it's also crucial that investors fully understand the approach in play at a prospective holding. Hedging policy is a key differentiator, but funds also vary substantially in their country exposures and their approaches to owning government-issued and corporate debt, among other factors. This article outlines some of the key considerations for world-bond-fund investors, and senior analyst Karin Anderson shares some must-knows for emerging-markets-bond investors in this video.

Morningstar's favorite funds in the world-bond and emerging-markets-bond categories showcase a broad range of strategies; most of them feature seasoned managers and reasonable, if not low, costs. Here's a closer look at some of our favorites.

PIMCO Global Bond (Unhedged) PIGLX

This Bronze-rated fund maintains an unhedged stance, meaning that it will tend to have much higher volatility than peers that hedge their foreign-currency exposures into the dollar. Senior analyst Karin Anderson notes that its baseline positioning isn't unlike that of its benchmark, an unhedged version of the JPMorgan GBI Global Index; that means it's heavy on government debt from developed markets. But, she notes, previous management's forays into sectors outside the benchmark, such as financial corporates and nonagency mortgages in 2008, have caused some wild swings in performance. Like many PIMCO funds, this offering was affected by Bill Gross' departure from the firm in late 2014. Former manager Scott Mather took on new responsibilities after Gross' exit, including managing

Anderson says that, in several key respects, this Gold-rated fund is among the boldest in the world-bond category. Whereas many rival funds focus largely on developed markets, manager Michael Hasenstab has bet against the euro and the yen. Believing that emerging markets offer better fiscal prospects than developed, he has steered half of its portfolio to developing-markets bonds, and two thirds of the portfolio's currency exposure comes from the developing world. Anderson notes that Hasenstab takes few risks on the interest-rate front, however, maintaining a shorter duration than most of his peers. Owing to its emphasis on emerging markets, performance here has a tendency to move in sympathy with risky assets; its return pattern has been highly correlated with equities. Nonetheless, the fund remains Morningstar's highest-conviction pick in the world-bond category, owing to Hasenstab's experience, a strong analyst team, and the fund's differentiated process. Here again, investors may pay a sales charge to gain access.

Emerging-Markets-Bond Funds

As Anderson points out in

, emerging-markets-bond funds tend to employ one of a handful of strategies. This Silver-rated fund was one of the first in its category to use a combination, or blended, approach, focusing on local-currency sovereign bonds, hard currency (U.S.-dollar-denominated) sovereign bonds, and corporate bonds. Its managers have put this flexibility to good use over their tenures, helping the fund to put up strong numbers in a variety of market environments. Like any emerging-markets-bond fund, this one's risks aren't insubstantial: Anderson notes that the local-currency exposure can put the fund at a disadvantage on occasion, and the fund's corporate-bond stake can also spell trouble in "risk off" markets. However, the fund's managers are highly experienced and backed by a deep and seasoned team of analysts, and its fees are reasonable alongside other no-load emerging-markets-bond funds.

Senior analyst Cara Esser reports that this fund's evolution mirrors that of the emerging-markets-bond universe at large. Whereas it generally focused on dollar-denominated sovereign emerging-markets bonds upon its launch--and such bonds still take up the bulk of the portfolio--it now can and does own local-currency and corporate emerging-markets debt as well. Esser notes that T. Rowe has scaled up the firm's emerging-markets research team accordingly, and manager Mike Conelius now relies upon a team of more than 12 analysts focusing on emerging-markets sovereign and corporate bonds. Owing to its deep team, flexible approach, and reasonable price tag, the fund earns a Bronze rating.