Investors are provided with two options in case they wish to invest in emerging market bonds. The first option involves investing in the dollar denominated debt that developing nations of the world issue. In simple terms, being dollar dominated means that the bonds are issued in United States dollar terms, therefore when US investors are purchasing them there is no need to make a conversion into foreign currencies. The result of this is that apart from currency risk volatility that is associated with the bond markets, there is no much impact.
The second alternative involves a bond that has been dominated into local currencies rather than United States dollars. In such a situation, an investor will be required to convert their money into other currencies before they can actually purchase the bond. For this to happen, they will be affected by the underlying fluctuations in the prices of the bonds as well as those of the currency.
A reason for this is best illustrated by an example. Suppose an investor purchases a debt worth one million dollars in Brazilian local currency, but first have to convert their dollars to the local currency before doing so. The bond price is exactly the same one year later, but the currency has appreciated by 5% versus the dollar. When the bond is sold by the investor and converted back to US dollars, there is a 5% gain in the investment value, even if the bond price itself was unchanged.
Anyone who wants to set aside a segment of their portfolio must select either local currency dominated or dollar dominated bond fund. When one chooses the local currency options, they can enjoy two benefits. One is that investors are allowed to branch out their holdings from the dollar. The other benefit there is a stronger economic growth that emerging market nations may have. Investors can benefit from what the growth brings to their country over time.
However, currency exposure at the same time adds another volatility layer. This becomes especially important in times when an investor is looking to avoid risk. On such times, it is reasonable to expect local currency funds to underperform when compared to their dollar denominated counterparts. Therefore a dollar based debt may turn out to be the better alternative for an investor in the asset or one with a somewhat lesser tolerance for risks.
From an asset class that was extremely volatile in the 1990s, emerging market bonds have evolved to a large and more mature segment of worldwide financial markets today. Developing nations have made gradual improvements in terms of the financial strength of issuing countries, political stability, as well as well planned government fiscal policies.
Several developing countries may have problems with budget deficits together with large debts, but most of them are finding ways of overcoming these limitations. Collectively, most of them enjoy healthier economic growth rates when compared to developed countries.
The outcome is that despite the yield being lesser now than they were in the 1990s, prices are now showing more stability. All in all, the emerging market bonds always have a vulnerability to external shocks that is capable of weakening investors appetite for risk. Hence, the asset class retains its volatility despite the elementary improvements in the motivating countries economies.
The second alternative involves a bond that has been dominated into local currencies rather than United States dollars. In such a situation, an investor will be required to convert their money into other currencies before they can actually purchase the bond. For this to happen, they will be affected by the underlying fluctuations in the prices of the bonds as well as those of the currency.
A reason for this is best illustrated by an example. Suppose an investor purchases a debt worth one million dollars in Brazilian local currency, but first have to convert their dollars to the local currency before doing so. The bond price is exactly the same one year later, but the currency has appreciated by 5% versus the dollar. When the bond is sold by the investor and converted back to US dollars, there is a 5% gain in the investment value, even if the bond price itself was unchanged.
Anyone who wants to set aside a segment of their portfolio must select either local currency dominated or dollar dominated bond fund. When one chooses the local currency options, they can enjoy two benefits. One is that investors are allowed to branch out their holdings from the dollar. The other benefit there is a stronger economic growth that emerging market nations may have. Investors can benefit from what the growth brings to their country over time.
However, currency exposure at the same time adds another volatility layer. This becomes especially important in times when an investor is looking to avoid risk. On such times, it is reasonable to expect local currency funds to underperform when compared to their dollar denominated counterparts. Therefore a dollar based debt may turn out to be the better alternative for an investor in the asset or one with a somewhat lesser tolerance for risks.
From an asset class that was extremely volatile in the 1990s, emerging market bonds have evolved to a large and more mature segment of worldwide financial markets today. Developing nations have made gradual improvements in terms of the financial strength of issuing countries, political stability, as well as well planned government fiscal policies.
Several developing countries may have problems with budget deficits together with large debts, but most of them are finding ways of overcoming these limitations. Collectively, most of them enjoy healthier economic growth rates when compared to developed countries.
The outcome is that despite the yield being lesser now than they were in the 1990s, prices are now showing more stability. All in all, the emerging market bonds always have a vulnerability to external shocks that is capable of weakening investors appetite for risk. Hence, the asset class retains its volatility despite the elementary improvements in the motivating countries economies.
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