Buy Emerging-Markets Bonds

Turmoil in emerging markets is the culprit of choice for the U.S. stock market’s sputtering start in 2014. Traders worry about slowing growth, fragile currencies and political unrest in Turkey, Ukraine and elsewhere. Never mind that U.S. economic indicators are green and that Europe again has a pulse. It doesn’t take much in this inter­related world to end what one commentator recently called “bliss” in financial markets.

I worry that emerging-markets stocks, which got off to a terrible start this year, will continue to sag. However, if you hop to the developing world’s bond markets, the vibes change. With bonds, the swings and the emotions aren’t as wild. You should do okay this year, certainly better than in 2013, when the average emerging-markets bond mutual fund lost 7.3%, mostly because of appreciation in the dollar. The typical emerging-markets bond fund yields 5% to 6%, and the income is generally secure. Few countries are close to reneging on their obligations. And keep in mind that emerging-markets debt isn’t synonymous with government bonds. Scores of vibrant, investment-grade, multinational firms that focus on oil, mining, agribusiness, brewing and construction are based in the developing world. These companies pay about two percentage points more to borrow than similarly rated U.S. and European firms.

Developing countries have worked hard to erase the stigma of needing one bailout after another from the International Monetary Fund during the 1980s and 1990s. IMF data shows that developing countries (not including China) now have more than $4 trillion of hard-currency reserves and relatively low debt. Brazil owns $247 billion worth of U.S. Treasury obligations, and Turkey owns $53 billion. Even the impoverished but fast-growing Philippines has $40 billion. Bond rater Moody’s considers the dollar-denominated debt of all three nations to be investment-grade. (Standard & Poor’s rates Turkey BB+, one tick below investment-grade status.)

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These trillions are more than just symbols of progress. The wealth provides a shark-filled moat to defend against speculators who might try to destroy a country’s currency and the value of its bonds and foment even more chaos. It is comforting to know that on January 24, when the Dow Jones industrial average plunged 318 points because of concerns about emerging markets, Moody’s praised Slovenia and implied that its government bonds could soon receive an investment-grade rating.

I don’t want to give you false hope that emerging-markets bonds will deliver a steady diet of double-digit total returns, as they did for most years from the mid ’90s through the mid ’00s. That period was Emerging Markets 1.0, says Peter Marber, head of emerging markets for Loomis Sayles. We’re now in Emerging Markets 2.0, he says, a time of “growing pains” and “adjustment periods,” but not one that will precede a return to the dark days.

My favorites. If you’re willing to take some risk with part of your income portfolio, you can find a number of well-run, no-load emerging-markets bond funds. My favorites are Fidelity New Markets Income (symbol FNMIX, recent yield 5.4%), a member of the Kiplinger 25; DoubleLine Emerging Markets Fixed Income (DLENX, 5.3%); and Payden Emerging Markets Bond (PYEWX, 5.6%). There are also some 20 exchange-traded funds that specialize in this sector.

Avoid funds with “local debt” in their names. They buy bonds denominated in the home nations’ currencies, adding an unwelcome element of currency risk. The dollar will keep getting stronger, but as long as developing nations have $4 trillion in their Treasuries, odds are good that you’ll get paid. In greenbacks.