July 3, 2003

Global Bond Funds -- Mid-Year 2003 Review

Emerging Markets Fly First Class

July 2, 2003 -- The first quarter of 2003 provided the ideal scenario for strong global bond performance: the spectre of war, stagnating economies, weak stock markets, corporate governance disasters in the U.S., and investors seeking refuge from equity markets. While some of these conditions eased in the second quarter, global bond funds continued to attract cash and perform well.

With few exceptions, global bond funds have delivered positive returns so far this year. The average global bond fund gained 10.5% in the first half. Within the category, emerging-markets bond funds raced ahead. In a clean sweep, the five best global bond portfolios for the first half of the year all invest in emerging market debt.

In short, emerging market bonds have been buoyed by political and economic reforms in certain countries, rising oil prices in others, and a deluge of new cash into the category. Kristin Ceva, who runs Payden Emerging Markets Bond Fund/R (PYEMX), said she is still seeing strong interest in fixed-income securities, particularly emerging market and high-yield bonds. "Investors are seeking yield in this low interest rate environment," she noted.

Ceva attributes the strong performance of emerging market debt primarily to "strong technicals," but adds that "fundamentals in key countries such as Brazil and Russia have been supportive as well."

Robert Kowit, portfolio manager of Federated International Bond Fund/A (FTIIX), noted that emerging market bonds are in a new phase in their evolution because as the credit quality of some countries, like Mexico, have been upgraded to investment-grade status, the sector is attracting a larger and more stable pool of investors, including institutions such as pension funds, endowments and insurance companies.

"For the past five years, credit quality of emerging market debt has been improving," Kowit said. "The average credit for the sector as a whole is now a solid BB. In fact, there have been two upgrades for every downgrade over the last five years -- this is unmatched by any other fixed-income sector." Ceva believes more emerging market nations will have their sovereign debt upgraded in the near future.

With an emphasis on valuation and high credit quality, Ceva is particularly bullish on the sovereign debt of Russia, long-term convergence plays like Bulgaria and Romania, and select countries in Latin America. She is currently avoiding distressed-credit nations like Venezuela and Turkey.

Ceva believes that emerging market debt should perform well the rest of the year, but most likely not as strongly as in the first half. She noted that the debt of emerging markets is "more vulnerable now to profit-taking and U.S. Treasury weakness, as we have seen in last week's selloff in the emerging markets."

Kowit concurs, believing that the biggest risk facing emerging markets debt going forward lies in the U.S. Treasury market. "If U.S. Treasury prices decline and interest rates were ever to move up, even if the spread in emerging market debt remains the same, emerging markets bond prices will go down," he said. "Looking at the rest of 2003, conservatively, in a best case scenario, emerging market bonds will probably earn the coupon and a small amount of performance. I don't think we will continue to see the spectacular performance that we've been seeing."

As far as bonds in the developed world go, Kowit thinks European bonds will outperform their U.S. counterparts since European central banks did not cut interest rates as aggressively as the Fed. As a result, Europe has more room to cut. "This is good for their bonds for the long-term," he says. Indeed, after the European Central Bank reduced interest rates by 50 basis points to 2.0% recently, many are anticipating another cut by September to pump up a still lethargic economy.

"We are also witnessing an investment culture in Europe that is becoming more fixed-income oriented," Kowit added. "So I doubt there'll be any massive flight to equities from bonds in Europe, even if the stock markets and economy there get stronger."

--Palash R. Ghosh

GLOBAL BOND FUNDS

Best PerformersMid-Year 2003

Returns (%)Worst PerformersMid-Year 2003

Returns (%)

AllianceBernstein Emerging Market Debt/A (AGDAX) +25.9Turner Funds Total Return Fixed Income (THQFX) -1.5%

GMO Tr Emerging Markets Fund/III (GMOEX) +24.3Morgan Stanley Inst Adv Foreign Fixed Income/Is -0.6%

SEI Intl Tr Emerging Markets Debt Port/A (SITEX) +22.9DFA Invest Grp Two-Year Global Fixed Income (DFGFX) +1.5%

Salomon Brothers Instl:Emerging Markets Debt (SEMDX) +22.1AllianceBernstein Multi-Market Strategy Tr/A (AMMSX) +1.8%

PIMCO Funds:Emerging Markets Bond Fund/Instl (PEBIX) +22.0Smith Barney World Fds:Global Govt Bond/B (SBGBX) +2.1%

GLOBAL BOND FUNDS

Best PerformersSecond Quarter 2003

Returns (%)Worst PerformersSecond Quarter 2003

Returns (%)

GMO Tr Emerging Markets Fund/III (GMOEX) +15.1Turner Funds Total Return Fixed Income (THQFX) -1.7%

AllianceBernstein Emerging Market Debt/A (AGDAX) +14.1Morgan Stanley Inst Adv Foreign Fixed Income/Is -0.9%

CDC Nvest Strategic Income Fund/Y (NEZYX) +12.6FFTW Funds International Portfolio (FFIFX) -0.6%

T Rowe Price Emerging Markets Bond Fund (PREMX) +12.2FFTW Funds Worldwide Portfolio (FFWWX) +0.8%

Merrill Lynch World Income Fund/I (MAWIX) +12.1DFA Invest Grp Two-Year Global Fixed Income (DFGFX) +0.8%

Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Data as of 6/30/03.

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