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Beat the Stock Market With Emerging Market Bonds

The risk factor has fallen

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Diversify for Safety

For safety, I recommend buying a well-diversified fund of EM bonds, such as no-load TCW Emerging Markets Income N (MUTF:TGINX). TGINX currently yields 7.3%.

That’s nifty enough, but get this: Over the past five years, the TCW fund’s share price has fluctuated, month to month, 34% less than the S&P 500 index.

I’m not saying TGINX is some kind of money market fund. The share price will bounce around, sometimes more than you might like — such as in September and October when investors around the globe worked themselves into frenzy over the woes of the European banking system.

Compared with a typical stock fund, however, TCW Emerging Markets Income is a model of stability. If you’re tired of the Dow’s extreme volatility, here’s an opportunity to take a break and still earn stock-like returns.

Closed-End Discount

My other route into EM bonds is through a closed-end fund, Western Asset Emerging Markets Debt Fund (NYSE:ESD). As the name implies, closed-end funds don’t continuously issue and redeem shares. Instead, you generally have to purchase shares on the stock exchange from an existing owner. Likewise, to sell, you normally have to place an order with your broker, and the exchange matches you up with a buyer.

Because it’s set by supply and demand in the open market, the share price of a closed-end fund can drift away — sometimes far away — from net asset value (NAV — the value of the securities in the fund’s portfolio). I prefer to buy closed-ends when they’re trading at discounts to NAV. In effect, I’m buying $1 of assets for less than a buck, which increases my cash yield.

At last glance, ESD was quoted at a juicy 11% discount to NAV. Thus, you can buy $1 of emerging-markets bonds, professionally managed, for only 89 cents. Current yield: 7.2%.

With the discount, you might expect ESD to yield significantly more than the open-end TCW fund. Why doesn’t it? Approximately 60% of ESD’s portfolio consists of government bonds, while the TCW fund is only 20% in government paper.

In other words, ESD follows a more conservative investment strategy. Government bonds nearly always yield less than corporate bonds, so the discount, in ESD’s case, helps lift your yield on emerging-market government bonds to essentially the same level as corporate bonds. The extra safety comes free.

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