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Investors Chasing Returns With Emerging-Markets Bond Funds

After posting strong returns in 2016 and 2017, this category may be tested in 2018 by rising global interest rates and bouts of volatility.

Benjamin Joseph: In 2017, all parts of the emerging-markets bond spectrum had a very strong year. Indeed, the JPMorgan EMBI Global Diversified Index of U.S. dollar-denominated sovereign bonds delivered 10%, while the JPMorgan GBI-EM Global Diversified Index of local currency bonds delivered 15% in U.S. dollar terms.

Despite Venezuela's default in November 2017 emerging-markets countries have broadly seen their currencies strengthen in 2017, helping to curb inflation and providing flexibility for some central banks to provide policy support. General strength across emerging markets came from the large commodity-related economies of Russia and Brazil returning to positive growth, higher and more stable oil prices, and general stability of Chinese growth.

In January 2018, global equity markets reached record highs before a market sell-off turned into a correction in the last days of the month. The EM bond markets cooled off as well. The dollar bounced back in February which negatively impacted the local currency bonds. Thanks to a strong 4.5% return in January, the local currency index remains in the black for the year to date through February 2018 with a performance of 3.4%. Over the same period, the hard currency index lost 2%.

Despite a historically unfavorable environment combining a substantial rise in global interest rates and bouts of volatility, investors' chase for yield continues to benefit emerging-markets fundraising. As assets continue to pour into this category, it is important that investors are cognizant of the volatility and credit risk inherent in this asset class.