Attractiveness of emerging markets

I am one of many investors who hold South American bonds - namely Venezuela, Colombia and Argentina. I invested in these for two-three years and have not therefore had a very profitable period. Is there a future in bonds of such emerging markets, or should I sell out and effectively cut my losses?

Bonds have generally appealed to the cautious investor as they are not correlated to the stock market but instead provide a steady income stream with the return of capital on the bond's maturity.

Regrettably, it is not quite that straightforward as investors in the past few years have found out to their peril. What investors have failed to recognise is that there is always a risk that the bond issuer may fail to meet its debt obligations.

A simple approach of determining a bond's 'risk' is by its credit rating from one of the leading research companies, such as Standard & Poors. Bonds of investment grade are naturally far more secure with bonds graded from AAA downwards to C before they fall out with investment grade. A bond therefore of AA rating is far more secure than one which is B.

Bonds in emerging economies such as Venezuela are typically CCC rated, which suggests a much higher risk than, say, a AAA-rated bond from General Electric or the European Investment Bank.

With risk however comes reward as one can expect interest of 10% or more from a CCC-rated bond compared to 5% from a AAA-rated one. You must however consider the capital risk inherent with the emerging market bonds.

Whether you should sell your current holdings or not will of course depend on your attitude to the risk you are currently taking and what your income requirements are in relation to the risk you wish to take.

If you decide to remain invested in such bonds then you may wish to consider investing via funds as opposed to directly buying bonds. In doing so, you are dramatically reducing the risk on your capital as the fund may hold 20 or more individual bonds. The impact of one of these bonds defaulting is therefore much, much less within the fund.

There are good, renowned emerging market bond fund managers who have made incredible returns over the past two years at times when investors who bought bonds directly may potentially be nursing heavy losses. The average return from the 83 emerging market bond funds over the past 12 months has been +25%. This assumes income has been reinvested (source Standard & Poor's, May 19). The fund route leaves the decision of which bonds to buy in the hands of full time fund managers and reduces the risk of you personally selecting what to buy.

Please address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively he can be contacted on 2137-7920/9984-2614 (office hours), fax 2137-7922, e-mail: admin.malta@ fpc-int.com.

Past performance is no guide to the future and except where amounts are guaranteed the price of your investments (and the currency in which it is denominated) may fall as well as rise. Malta exchange control regulations must be observed. Your personal tax situation will depend upon residence, always consult a professional adviser. This article does not intend to give investment advice and the contents therein should not be construed as such. Readers are encouraged to seek professional advice regarding their personal financial situation.