High yields or high risk

My portfolio consists entirely of South American bonds - denominated in either US dollars or sterling. I have invested in this way for nearly ten years and have done very well. The only bond I have lost on was Argentina. What is the likelihood of Argentina recovering and can I reduce the risk of holding individual bonds but still receive a yield of 7-8% in emerging markets?

The default on Argentinian debt goes back nearly three years and, with no interest being paid and the capital value losing in the region of 75%, very little is going to change. Discussions have been going on as to how the debt will be restructured but, whatever the outcome is, investors will receive back a fraction of what they invested.

These bonds must unfortunately be effectively written off. I see very little point in retaining a bond that is paying no interest and has lost 75% in value. One should consider trying to sell on the open market and try to recover the losses through a more appropriate equivalent.

The Argentina default highlighted the lack of knowledge of investing in emerging market bonds. The risks are very high when buying individual bonds but regrettably investors seem to be ignoring these warnings as they continue to gamble on yields of 10% or more.

I have no objection to these bonds forming part of an overall portfolio but exposure should be restricted to 5%-10% for a typical balanced investor. The norm among local investors, however, is the other extreme, with many investors holding direct bonds in countries where you would certainly not contemplate taking a vacation!

Bonds in emerging economies, such as Venezuela or Colombia, are typically CCC-rated, which suggests a much higher risk than, say, an A or AA-rated corporate bond. With risk however comes reward as one can expect interest of 10% or more from a CCC-rated bond compared with 6% from a A or AA-rated one. You must however consider the capital risk inherent with the emerging market bonds.

A more appropriate means of gaining exposure to emerging market bonds is through an investment fund. In doing so you can hold anywhere in the region of 30-300 individual bonds in one fund. The impact of one of your holdings defaulting is therefore drastically reduced when compared to holding individual bonds.

There are good, renowned emerging market bond fund managers that have consistently delivered returns of 7%-10% per annum over the last three or more years through managing diversified portfolios. Importantly, the fund managers are actively trading bonds - getting out of unsecure holdings and buying at cheap opportunities. All of this is being done through a rigorous research process on your behalf.

The question remains as to whether you and/or your stockbroker is providing the same service as these fund managers do and what the price is of going it alone. Personally and professionally, I would prefer a 7%-8% yield knowing my funds are being managed expertly as opposed to receiving 10% and hoping for the best!

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. 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.