In Uncategorized on December 7, 2009 at 16:43

Would you lend money right now to the government of Dubai?

To most ordinary investors the question may sound crazy. The Gulf emirate, after all, has just sparked a panic after Dubai World, a separate but government-controlled conglomerate, announced it needed to renegotiate terms on at least some of its $59 billion debt.

At times like this, members of the investing public understand why emerging market bonds—those issued by developing countries—are usually described as high-risk assets.

But the question to ask is not how much risk you’re willing to stomach, but how much you might be paid to take that risk. During the past 15 years we’ve had plenty of emerging-market crises, including the Asian Tigers collapse in 1997, the SARS panic in 2003, and of course last year’s financial crisis. And don’t forget, the Russian government actually defaulted on its bonds in 1998.

Nonetheless, emerging-market bonds overall have proved very good, though volatile, investments. Investors have endured some stomach-churning drops during the crises, but someone who held a broad basket of those bonds in a mutual fund, which reduces your exposure to individual issuers, has done well.

Consider the performance of the Morgan Stanley Emerging Markets Debt Fund , which invests in these types of bonds.

If you had invested $100 in this fund 15 years ago and just left it there, reinvesting your dividends, you’d have nearly $500 today. That’s about twice what you’d have if you had put the same amount in a typical basket of conservative U.S. corporate or Treasury bonds over the same time.

For most of that time, emerging-market bonds were cheap, because most investors were afraid to own them. So the investors who did reaped big rewards. Whether that is still the case is another matter. Emerging markets bonds are no longer anywhere near as cheap as they were.

One good measure of a bond’s value is the yield. As prices fall, the yields rise. At times—such as in 1998, and again in 2008—the annual yield on Barclays Capital’s emerging markets bond index has been well into the double-digits.

In the case of Dubai, there is little reason at the moment to believe the state would default on its own sovereign bonds. To allow such a default would be a monumental act of folly on behalf of the oil-rich United Arab Emirates, of which Dubai is a part. (Remember, Dubai World, the conglomerate that just defaulted on its debt, is owned by the government but is a separate entity.)

Thanks to this weekend’s panic, some Dubai government bonds, which come due in five years now yield about 9%.

They could be a bargain. But Dubai bonds are hard for individual investors to own, because they are traded over the counter and volumes are thin. So these are an investment for sophisticated investors only. Middle Eastern countries account for very little of the global inventory of emerging-market debt. (The bulk of the market is comprised of bonds issued by big countries like Brazil and Russia.)

The more relevant question for the individual investor is whether now’s a good time to buy shares in an emerging-market bond fund.

If the Dubai affair had caused a wider panic, the answer would probably be yes. But it hasn’t, at least not yet. Emerging-market bonds in general have boomed this year, sending the yield on the Barclays index down to about 6.6%. That’s nearly as low as it was two years ago, just before the big crash.

Abby McKenna, who runs the Morgan Stanley fund , sees a few opportunities right now. She’s been buying certain bonds issued by Brazil, Mexico and Indonesia, and says she’s found better values in bonds issued in local currencies rather than in U.S. dollars. Her fund, a closed-end one that trades on the stock market, has a distribution yield of 8.1%.

One reason: Right now the shares sell for about 10% less than the underlying value of the investments. For anyone with money to invest right now, that sort of discount has to help your odds.

But even better opportunities will doubtless come whenever the next big panic strikes and experts start hollering at investors to avoid emerging-market risk.


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