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3 Funds for Emerging-Markets Bond Exposure

Amid a mixed start to 2021, here are three compelling options for a stake in the sector.

A version of this article was published in the June 2021 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting the website.

Following a rebound over the last nine months of 2020, emerging-markets bonds have had a shaky start to 2021. The JPMorgan EMBI Global Diversified Index, which tracks U.S.-dollar-denominated emerging-markets sovereign debt, dropped 4.5% during the first quarter under pressure from rising U.S. rates and inflation concerns. While the index has begun to climb back as rates have stabilized and global growth expectations have improved, it remains in negative territory, with a 0.5% fall over the year to date through June 18, 2021. Weakness in emerging-markets currencies relative to the U.S. dollar has left local-currency emerging-markets sovereign debt worse off; the JPMorgan GBI-EM Global Diversified Index declined 3.8% over the same period.

Despite the mixed start to the year, emerging-markets debt could be an attractive option. While the intermediate government Morningstar Category offers a median SEC yield of 0.8%, the emerging-markets bond and emerging-markets local-currency bond categories have median SEC yields of 3.9% and 4.2%, respectively. Those yields also top the median high-yield bond fund's SEC yield of 3.7%.

However, emerging-markets bonds carry amplified risks alongside their lofty yields and can move more in line with equities than developed-markets debt. Political, macroeconomic, and regulatory developments can all impact credit risk and introduce volatility. Sovereign issuers are a mix of investment-grade and junk-rated. The risks are real. Argentina has defaulted twice in the last 10 years, most recently in 2020. Local-currency-denominated emerging-markets debt also adds very potent currency risk into the mix. Given the elevated risks, emerging-markets bonds are best suited for a supporting role in a portfolio.

For investors seeking a dedicated strategy, TCW Emerging Markets Income TGEIX, which has a Morningstar Analyst Rating of Gold, is a compelling option that has the flexibility to invest across the sector. While the strategy is benchmarked against the JPMorgan EMBI Global Diversified Index, it also has the ability to invest in corporates, which can represent up to half of assets, and local-currency sovereigns, which are limited to a third of the portfolio but have been kept to low single digits in recent years. The strategy's seasoned managers have put its flexible approach to good use over time. Since the current management team formed in December 2009 through May 2021, it bested both its index and 95% of distinct emerging-markets bond category peers.

Another way to gain exposure is through a bond strategy with a meaningful allocation to the sector. Silver-rated Pimco Diversified Income PDVAX, which resides in the multisector bond category, typically allocates around a third of assets each to investment-grade corporates, high-yield corporates, and emerging-markets debt. Hard-currency sovereign and quasi-sovereign debt typically make up the bulk of its emerging-markets exposure, limiting the impact of volatile currency swings. Few firms can compete with Pimco's considerable resources. This strategy benefits from comanagers Sonali Pier, Eve Tournier, Dan Ivascyn, and Alfred Murata; the latter two are past Morningstar Fixed-Income Fund Managers of the Year. Successful incorporation of its emerging-markets stake has given a boost; it handily outperformed its typical category peer since its current management team formed in April 2016 through May 2021.

Gold-rated Dodge & Cox Global Bond DODLX is a world-bond fund with a tilt toward corporate bonds. The firm's global fixed-income investment committee manages it alongside a deep and experienced team of researchers. The managers here build a concentrated, high-conviction portfolio with a notably high corporate credit stake, which typically represents half of the portfolio. Within its emerging-markets allocation (26% of assets in March 2021), it sports a mix of mostly local-currency sovereign debt (19%) and corporates (4%). The managers tend to keep foreign-currency exposure to around 20% on average. Its allocation to emerging-markets debt has helped it serve investors well over time. From its 2014 inception through May 2021, it outpaced both the Bloomberg Barclays Global Aggregate Hedged Index and all distinct category peers.

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