Among the riskiest investments available to U.S. investors, emerging market bonds have delivered outsized gains over the past few years. The bonds have benefited from volatility in developed-country equity markets, leading to high cash inflows, and from investors’ increased appetite for higher-yielding securities. Through the 12 months ended October 29, the average emerging markets bond fund gained 13.1%, while the S&P 500 Index rose 9.5%. Over the longer term, the outperformance is more dramatic: for the five-year period, the average emerging markets portfolio climbed 16.1% on an annualized basis, while the S&P 500 fell 2.2%.
A common misconception about these bonds is that they are of below-investment-grade quality. However, several developing nations, including Mexico, Malaysia, and Singapore, have seen their sovereign debt upgraded in recent years. Moreover, as emerging market bonds exhibit very low correlation with U.S. equity and bond markets, they could help to mitigate volatility in an investor’s overall portfolio. Along with the higher risks come higher yield and higher potential price appreciation.