Attraction of emerging markets

I previously invested in emerging market bonds - purchasing Brazilian and Venezuelan debt in particular. I am concerned of the high risks associated with buying bonds directly and am looking for an alternative way of achieving similar returns but without the exposure to only two or three bonds. I hold euro and sterling, but am not concerned which currency I actually invest in.

Regular readers of this column will know my views of private investors buying individual bonds. It is one thing buying secure, high-rated bonds but another thing if 90 per cent of your portfolio is invested in a handful of high-risk, emerging market bonds.

Investors have had their fingers severely burned by adopting the second approach, and, unless you are prepared for the risks, my general advice is simply not to do it.

The natural alternative is to look for a fund that invests in emerging market or global high yield bonds. Many such funds also distribute a regular half yearly or annual income.

A typical income yield would be in the region of 7-8% in US dollars for funds that include solely emerging market debt. Such a yield should prove very attractive, especially in US dollars, due to the corresponding low deposit and treasury yields on dollar.

Added to that is the fact that a fund may include in excess of 50 individual bonds. The impact of default on any of the holdings is therefore much less relevant than if a default occurred on one of your handful of bonds if bought directly. In emerging markets, due to the high risks, diversification is more important than ever.

In addition, a typical emerging market bond fund will be spread across bonds from Latin America, Asia and Eastern Europe, plus others. Do not therefore assume that emerging market bonds come only from Latin America.

Tremendous gains have been made over recent years from Eastern Europe in particular and this region must not be overlooked.

In your case, as you hold euro and sterling, you may wish to add an element of speculation by investing in a dollar-denominated fund. The dollar is very weak at the moment against both currencies that you hold.

If you are investing for a three- to five-year period then I would predict that the dollar will strengthen by the time you redeem your investment. If that is the case, then you may profit from the currency hedge alone.

It is a very good time for those holding euro and sterling to invest in dollars based purely on the recent historic movements between the currencies.

In summary, I would suggest one or more emerging market or global bond funds that pay a regular income yield. Most funds are denominated in dollars which could be advantageous if investing for three or more years.

You must, however, always observe the risks including currency movements.

Mark Hollingsworth is the director of Hollingsworth International Financial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/9984-2614 (office hours) or e-mail mh@hollingsworth-int.com.

Past performance is no guide to the future and, except where amounts are guaranteed, the price of your investments (and the currency in which it is denominated) may fall as well as rise. Malta exchange control regulations must be observed. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.