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. Last Updated: 07/27/2016

Bond Funds Thrive In Emerging Markets

It's no secret that investors lost tons of money last year in stock funds that invest in Latin America and other emerging markets. What is a secret is that many other investors made money by buying bond funds that invest in the same regions of the world.

Investors in emerging-markets stock funds lost 4.6 percent during 1995, while those who held shares in Latin America stock funds fared even worse, losing a whopping 20.6 percent.

All the while, investors in all emerging-markets bond funds gained an average of 20.1 percent, according to Lipper Analytical Services Inc.

After the dramatic devaluation of the Mexican peso in December 1994 -- which caused a stock-market crash and forced the country into a deep recession -- short-term interest rates rose from 18 percent to 70 percent. In what was called the "Tequila effect,'' the turmoil in Mexico spread to other Latin countries, where bond prices also fell sharply.

After the Mexican devaluation, the Latin bonds continued to sink until early March when the U.S. and international agencies agreed on financial aid to Mexico and Argentina. That lessened the chances the two nations might default on their bonds. It also brought foreign investors back to the Latin bond markets, where prices strengthened.

The massive sell-offs in the Latin markets also created buying opportunities for emerging-market fund managers in unexpected places, including Poland and Bulgaria, according to Michael Conelius, manager of the T. Rowe Price Emerging Markets Bond Fund.

While the Latin meltdown seemed justified by the default risk, Conelius said, it didn't make much sense in Eastern Europe. "The market painted all emerging markets with the same brush,'' Conelius said. Polish Brady bonds fell 7.8 percent; Bulgarian Brady bonds dropped 10.6 percent. That was Conelius' signal to buy, even though he said it was "like catching a falling knife.''

When the rebound came in April, the Polish bonds rose 12.3 percent and the Bulgarian bonds climbed 15 percent.

Several managers said they expected this year's returns to be paler versions of last year; others thought they would do as well. William Nemerever, manager of the GMO Emerging Country Debt Fund, said, "The outlook is still good, but I would counsel caution.'' Returns this year, he said, "will be nothing like last year.''

Nemerever suggests investors should think of the funds as stock funds that come with high "dividends.'' "The risks and returns are more similar to stocks than bonds,'' he said.