3 CEFs for Emerging Market Debt Exposure

"It was the best of times; it was the worst of times." Charles Dickens was obviously talking about today's investing climate. In my over 30 years of investing and watching the markets, I have never seen such diverging opinions about the values of stocks and bonds and the direction of the economy--U.S. and global. In the course of a few hours on CNBC (an expenditure of time that I do not recommend, if you are to be a successful investor), one can hear a pundit extol the virtues of a group of sectors and proclaim "this is where you should be putting your money." The very next guest may trash those sectors as dead money and then present another list of sectors and proclaim "these are the sectors that will do the best in this economy." Another may claim that U.S. stocks are the place to concentrate, while another "expert" says put most of your money outside the U.S. It can be very confusing if you listen to all the "noise," and that is the point: you have to block out the noise and stick with your asset allocation.

I think that includes some fixed income as well as equities, and I am writing to suggest that in a diversified portfolio, one should consider debt from emerging economies for a portion of one's bond holdings. There is certainly a difference of opinion about emerging markets as well, but I would humbly submit that if you consider emerging markets' equities, you certainly should consider emerging markets' debt. I would suggest that from 5-8% of the fixed income allocation of one's portfolio should be in emerging markets' debt to gain geographic, economic, and currency diversification.

In my opinion, emerging markets' debt offers 1) very good yields; 2) diversification; and 3) greater safety than corporate junk bonds. Yes, I think they are safer than corporate junk bonds. Emerging market economies are still growing, while the great ship of the U.S. economy is dead in the water, for the time being, at least. To me that spells less risk in debt outside the U.S. in lower quality issues.

I am going to briefly mention three closed-end funds that allow easy access to a diversified investment in emerging markets' debt instruments. These funds have different risk characteristics to consider. I strongly suggest that you go to the Morning Star website and review the portfolios of these funds for yourself.

First is the Templeton Emerging Markets Income Fund (TEI), which I consider to be the least risky of the three (risk measured by the economic and political stability of the issuing country). This fund carries a Morning Star rating of (***). With a price per share of just over $15.00, it yields 6.70% on a $1.00 per share dividend. (Note: the bonds pay interest, but the fund pays a dividend.) The fund has an expense ratio of 1.16%, and it sells at about a 2% premium (it sells slightly above the net asset value or NAV). The fund has been managed by Michael Hasenstab since 2002. The fund has total assets of over $700 million, and the manager is currently holding 6% cash in the fund. I like seeing a healthy cash position in any equity or bond fund right now. It shows the manager(s) can act to take advantage of opportunities as they arise. TEI is a very sound choice for getting into emerging markets' debt.

The second fund I offer for consideration is the Global High Income Fund (GHI). The fund has been managed by Uwe Schillhorn since 2003. The fund has earned a Morning Star rating of (****). Total assets are over $300 million. The recent price of the fund was slightly over $15.00 per share, which yields 8.5% on the $1.28 per share dividend. The expense ration is a bit hefty at 1.32%. The fund manager currently has 14% of assets in cash. That means the manager has over $40 million ready to invest when he finds the right opportunity. This fund is another sound way to get into emerging markets' debt. One thing that is something of a negative about this fund, at least to me, is that over 70% of the holdings are denominated in U.S. dollars. It does not offer as much currency diversification as the next fund.

The last fund may be the rogue of the three. It is the Morgan Stanley Emerging Market Domestic Debt Fund (EDD). It is a relatively new fund, opening in 2007. Total assets are over $1 billion, and over 50% of the holdings are in foreign currencies. The recent price per share was $17.59, and it yields slightly over 11% on the $2.00 per share dividend. The fund is jointly managed by Eric Baurmeister, Federico Kaune, and Abigail McKenna. The fund is not rated by Morning Star, and the fund sells at about a 1% discount to NAV. The expense ratio is 1.09%. Why do I call this fund a rogue? It may have the highest risk profile of the three based on its holdings. I own this fund. I am not suggesting you should too; I only suggest you should look at it. Once I decided to diversify into emerging markets' debt, I selected this fund primarily for the yield. If I am going to be in this space, I want to be paid well for it.

There are three funds you can look into if emerging markets' debt has a place in your fixed income portfolio. I believe it should. Research these and others before making a choice. The Morning Star website is a very useful tool.

Successful investing to you. Don't be blown off course by all the "hot air" trying to move the investing world. As Warren Buffett likes to point out, it isn't rocket science. Keep it simple. Watch your allocation.

Disclosure: The author has a position in EDD.

Comments

[User 23199]

How about the ETF, PCY?

[Indexor]

In the past, before we had ETFs such as BWX and PCY, I also used TEI, and to a much lesser extent GHI. Unless you are placing a couple hundred shares in your own account, BE CAREFUL using ANY CEFs. There is VERY little liquidity in these issues. Take a look at a chart of TEI for July and August of 2007. Trying to get out of this issue was totally impossible at that time. And with TEI over $15, if the dollar begins to strengthen, good luck with your exit strategy. Please do yourself and your clients a favor and look at PCY and other similar ETFs. CEFs should no longer be part of any advisor's strategy. Leave them to the pump and dump stockbrokers.

[whidbey]

These are no more risky than anything else that pays well. If you buy and hold for earnings, no trading, the trip is OK. But add some MLPs in the US and Canada oil for balance plus a few REITS. Nothing is perfect, but getting earnings today is worth the efforts required to sit still and watch the principal wax and wane. Good ideas for income.

[GlobalWarmingExaminer]

I also own EDD, mainly because I would looking for income producing bonds that were NOT denominated in US Dollars. Many of the funds buy bonds denominated in dollars.

[Jagor]

This is a good article. TEI and GHI are both great investments for income and both have highly-respected managers. As mentioned above, EDD is new, but it's good, too: it's yielding 11.12%. Another good one is Western Asset Emerging Mkt Floating Rate EFL. It's up an astronomical 36.86% YTD and is paying 7.03%. Unfortunately, it is now selling at a 21.07% premium.

[Rick45]

Own AWF (i.e. broke Res. here per div. hike this week): I like to mix with R.T.'s like HGT for low-beta income. Also have the wife in TEGBX per higher-quality debt.

PCY is a dog!

[Elliott]

I think ESD is outperforming EDD, IMHO. ESD yields 9.2% with a regular monthly dividend and can be had for a 10% discount. Highly rated by Morningstar. Top holdings are Brazil notes, a good move considering the recent upgrading of that nation's debt. Chart of ESD shows OBV is rising; NAV is going up, I think there will pressure on price that will take it up from $18 to $20.

[one taste]

I was in EDD and then recently out as the NAV/market price has closed. However, as of 4/30/08, etf connect reports management expenses at 2.21 and other expenses bringing your total expenses to 3.24. www.etfconnect.com/sel...

[one taste]

Also, MS has a EDD favored client share class that doesn't pay the management fee. So I like what they are doing, but don't appreciate the price tag.

[dfinn]

on june 16th: what happened to EDD Yikes!!!!!!!!!!