squawk wrote:From my limited understanding of foreign market bonds, many are dollar dominated due to past currency crashes.
The diversification factor is basically a risk premium on EM Governments vs. Developed Governments.
EM's crashed heavily in the 80's and 90's resulting in a higher risk premium since then.
The question is: will it remain?
I think it will because investors will always be more hesitant to lend to the government of Russia versus US Governments.
I am still neutral on them -- looking for more input
You're confusing several issues here:
There are EM bonds issued in USD which are also refered to as "Brady bonds." This is usually what you'll find in an EM bond fund. They have *had* equity like returns, but will act like EM stock and take a nose dive when they things go bad. There is credit risk here if the issuing countries currency drops and they don't have enough foreign reserves to buy dollars to pay the bond coupons. If it becomes too expensive they can default.
There are also EM bonds issued in local currency, but only a few funds have them. PIMCO has one. There is supposedly an ETF coming in this area containing corporate bonds. EM corporate bonds may have higher credit rating than the EM country they are located in. These will be volatile. In this case currency risk is on the bond holder and not the issuer.
There are EM "developing local currency" funds which are unhedged containing essentially MMF term bonds. The currency fluctuations make these pretty volatile. The credit ratings on these are higher because the term length is short. In this case currency risk is on the bond holder and not the issuer.
There are the usual unhedged foreign bond funds such as BWX and BWZ.
There are hedged foreign bond funds too. The strength of the hedge will show up as volatility. PIMCO's hedged foreign/global bond funds aren't strongly hedged so they have more volatility than US bond funds. DFA and Payden have strongly hedged bond funds that aren't any more volatile than US bond funds.
Index funds in this area are generally market weighted by the amount of foreign bond funds floated. PIMCO has a fund that is GDP weighted with the idea of reducing exposure to big borrowers such as the US and Japan.