Foreign Bonds or Emerging Market Bonds, which is better?
The United States is obviously not the only country which issues bonds. You can buy foreign bonds issued by other industrial power governments as well as foreign corporations. As mentioned previously, you have currency risk when you go outside the US Dollar with your investments, but if you believe the dollar will falter, you might see this as a big advantage. The key thing to look out for in buying a first world country’s bond is for the strength of the government’s finances and that country’s economy. In other words, do they export more than they import, or will the currency always be slipping because they need more from others than they can produce? Does the government run it’s book wisely or are they constantly overspending?
Emerging Market Bonds Are More Interesting…
Not all foreign bonds are created equal. Typically when you see a “foreign bond fund”, what you are really looking at is a bond fund which focuses on long established/industrialized countries. However, if you believe that one of the great stories of the next few decades will be the final emergence of the “emerging markets”, then this might be an exciting area for you to consider investing.
For decades, we in the west have considered “emerging markets” to be places that are inferior and looked upon them as being economies that will never catch up. However, these countries are rapidly growing today while the industrialized countries are trying to keep growth positive rather than negative.
Also, many of these countries have much less debt than the “first world” countries. Interestingly, the market still makes these countries pay a much higher interest rate because they are perceived as being more risky. When we examine the finances of the world’s leading economic powers, we question the validity of that assumption! So to us, this seems like an incredible opportunity.
Of course, the risks mentioned above still apply. There is certainly currency risk. This might help or hurt you depending on the direction currencies move. As with every bond, there is default risk. What you will notice with emerging market bonds though is that when markets crash, participants run away from risk. This means that these bonds will see their market value fall more substantially than US bonds or even European or Japanese bonds will.
However, if the day comes when the sovereign debt mess of the industrialized powers comes to a crises. It might just be that these emerging economies become the new leaders of the world. In this case, their bonds might be safer than US bonds.
So this is certainly a speculation because if another crises like 2008 comes along that doesn’t kick the US into a tailspin, you will see emerging market bonds fall substantially in market value (which might have nothing to do with their ability to actually pay you as promised.) This flight to safety could also cause the US Dollar to surge in value which would also harm the value of foreign holdings as also happened in the 2008 crises. So be prepared for risk, if you take a position here. But if you can handle this risk, these emerging market bonds might provide excellent diversification in you are concerned with a US Dollar devaluation, or if you simply see the rising tide of emerging markets continuing into the future.
Some other posts on Bonds we’ve done are: What is a Bond?, Treasury Inflation Protected Bonds, Shorting Treasury Bonds, Treasuries Might Be Risky, Are Other Bonds Risky?, & The Different Types of Bonds