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Emerging Markets Have Stung Some Core Bond Funds

It’s been tough sledding for core bond funds that ventured into emerging-markets debt.

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Emerging-markets debt is quite common within global, multisector, and nontraditional bond funds. It’s less well known, however, that emerging-markets bond allocations have become more common in core bond funds. In recent years, scores of intermediate-bond funds have sported high-single-digit to low-teens stakes in emerging-markets debt (that includes both U.S. dollar-denominated bonds as well as the much more volatile issues denominated in local currencies). Although the typical fund in the category has a mere 1% invested in emerging-markets debt and many funds have no allocation, today’s levels are still a good deal higher than a decade ago when the largest stakes came in around 5%.

After two strong years, the JPM EMBI Global Diversified Index, which contains emerging-markets bonds denominated in U.S. dollars, slid by 5% in 2018’s first half. But investors in local-currency bonds fared worse (the JPM GBI-EM Global Diversified fell by 6%) as the U.S. dollar rallied and most emerging-markets currencies sank, especially in the second quarter. The period is a good reminder why manager skill matters when incorporating emerging-markets bonds, and especially currencies, into core fixed-income funds. To illustrate, the Argentine peso fell by a staggering 35% versus the U.S. dollar in the second quarter of 2018 over concerns about the country’s significant external financing needs. The Turkish lira came under pressure (down 17% versus the U.S. dollar) following President Erdogan’s re-election, and investors were skittish about the Brazilian real (down 14%) given the resignation of Petrobras’ CEO and the central bank’s decision to keep rates on hold.  

Karin Anderson has a position in the following securities mentioned above: PTTRX. Find out about Morningstar’s editorial policies.