3 CEFs for Emerging Market Debt Exposure

Includes: EDD, GHI, TEI
by: Larry House

"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 (NYSE: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 (NYSE: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 (NYSE: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.