(PUB) Investing 2015

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Wide Range of Emerging-Markets Exposure in World-Bond Funds Income Strategist | Karin Anderson

takes on the most currency risk of the funds in this group. American Funds Capital World Bond targets sovereigns and corporates globally. Unlike the T. Rowe fund, it has a bit more leeway to invest in higher- yielding sectors like emerging-markets debt but attempts to minimize currency volatility. For instance, its managers kept emerging-markets currency exposure dialed down to a mid-single-digit stake re- cently. Loomis Sayles Global Bond has taken a more conservative stance in the past few years, which has included keeping its emerging-markets currency exposure in the single digits given its team’s views on volatility and a stronger dollar. This fund’s overall emerging-markets exposure could go much higher if its team finds valuations compelling. Sovereign-debt-focused Templeton Global Bond TPINX sports the most emerging-markets exposure, which recently clocked in at just over half of assets but gets closer to two thirds after including its South Korean stake. The fund’s currency exposures largely match the emerging-markets country it invests in, with notable shorts on developed-markets currencies including the yen and euro, which the team has maintained for years based on its view on a strengthening U.S. dollar. The other funds also manage currency exposure tactically. Dodge & Cox Global Bond DODLX , which invests broadly across sovereigns, corporates, and securitized debt, recently stashed nearly one third of assets in emerging- markets debt with the heaviest concentrations in Mexico and Brazil. Similarly, PIMCO Foreign Bond PFORX , which comes in U.S.-dollar-hedged and -unhedged versions, invests broadly across sectors and recently had a 20% emerging-markets stake though it has gone as high as one third of assets. The U.S.-dollar-hedged version of this strat- egy has experienced about half the volatility of its unhedged sibling over the long term and has been the least volatile of all the funds cited here. Generally, the other funds have benefited from their emerging-markets bond exposure over the long haul, although it’s resulted in varying levels of volatility. K Contact Karin Anderson at karin.anderson@morningstar.com

Global bond indexes have allocated increasingly more to emerging-markets debt over the past several years—for example, the Barclays Global Aggregate Index had a 16% stake as of September 2015 . Today, most world-bond funds invest at least 10% of assets in emerging-markets bonds, and some have 40% – 50% allocations. But higher-yielding emerging- markets bonds come with amplified risks. Emerg- ing-markets currencies have been extremely volatile in recent years and can easily wipe away the bonds’ yield advantage, though managers may fully or partly hedge this risk. Emerging-markets country funda- mentals can change quickly with changes in political regimes or geopolitical risk. Country and corporate defaults are another consideration, as are commodity price swings, which can weigh heavily on export- driven nations. These risks, in addition to the illiquidity of certain segments of this market, make emerging- markets debt subject to swift sell-offs. All of the global fixed-income funds in the Morningstar 500 have more than 10% in emerging-markets debt. Those with lower levels of exposure had stakes in the midteens as of June 2015 . These include T. Rowe Price International Bond RPIBX , American Funds Capital World Bond CWBFX , and Loomis Sayles Global Bond LSGBX . These three funds use either the Barclays Global Aggregate Index or Barclays Global Aggregate ex- US Index as benchmarks, but their approaches vary in some key ways. T. Rowe Price International Bond targets non-U.S. government and corporate bonds and leaves its over- seas currency exposure unhedged. Given that its management team tries to keep country and currency exposures roughly in line with the index, this fund’s largest emerging-markets exposures will tend to be in larger index constituents like Mexico, and the fund