Local rules apply

28 October 2010 By Agnes Crane

Investors hungry for yield and protection against a sagging dollar have this year gobbled up $23 bln of bonds in developingcountry local currencies. Some may be forgetting one key point amid the frenzy. If things go bad, sheriffs playing by different rules will lay down the law.

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Flows into emerging market bond funds are running more than four times higher than 2005, the previous best year. This year through September, local currency emerging market funds have taken in $22.6 billion, according to fund tracker EPFR. Overall, investors have poured a total of $41.7 billion into emerging market bond funds so far this year.

Yields in local currency bonds are much higher than those dominated in dollars. A Brazilian fixed rate bond due in 2017, for example, yields around 12 percent. Even with the 6 percent capital control levy, an investor would still earn more than 10 percent if he held it to maturity. A dollardenominated bond maturing in 2015 yields just 2 percent.

The size of the emerging market fixed income market is roughly $9 trillion with the local currency market accounting the vast majority of the total. According to Barclays Capital, global pension funds, mutual funds and insurance funds could have $14.3 trillion to invest if they decided to diversify 20 percent of their portfolios into emerging markets.

Transparency International in a recent report noted nearly threequarters of 178 countries in its corruption index scored below 5 on a scale of 0 (highly corrupt) to 10 (very clean). Though some countries in the advanced world scored very low notably Italy developing countries made up the vast majority of nations with serious corruption problems.

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