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Barron's had an article about the increasing popularity of emerging market debt. The article makes it seem like interest in this space is new but I seem to recall Bud Fox pitching the space early on in the first "Wall Street" movie.

Included in the article was a quote from a money manager who "recommends allocating as much as 35% of fixed income to the category." A big part of the story here is of course that things like Treasuries, money market funds and investment grade U.S. corporates pay very little interest by historical standards. If 10 year U.S. Treasuries paid 6% there would be less interest in emerging market debt -- that is not a commentary on fundamentals so much as an opinion that people would be plenty satisfied with that yield.

If you can accept that this is about yield then I would submit there are plenty of places to get yield without allocating 35% to any single segment. There are plenty of things that yield, 4-6% that don't take on absurd risk. Keep in mind that we live in a zero percent world so the more that is allocated to things that yield 4-6%, or higher, the more risk that is assumed.

We have exposure to emerging market debt through the PowerShares fund that has symbol PCY. Depending on the client we target 5-10% of the portfolio to the space with this fund. We have room for a little more exposure to the space but not much more IMO. The yield shows 4.75% but we've had it for a while and so our yield is a little better than that. There are other EM bond funds that yield more of course but going for yield at any cost, as indicated above, increases the risk assumed.

For many years I've written about our use of preferred stocks. Many clients own two different issues at a 5% target weight each. We could find ones that yield in the sevens but are quite comfortable in the high five-low six area.

We have used individual issues of foreign sovereign debt for many years now. Some countries provide very good yield and some don't yield as much. Individual issues can be difficult to access because of the minimum order sizes associated with the space but there are ETFs that offer the exposure too. Some clients own the WisdomTree Australia New Zealand Debt Fund (AUNZ) which shows a distribution yield of 3.46% (of course that is a backward looking number, it may yield more or less in the future).

Most clients also own the most boring closed end fund I know of, it is a very generic go anywhere fund. The name isn't that important as there are plenty that don't use a lot of leverage, don't trade at a gross premium to NAV and aren't that volatile. Some closed end bond funds can be nauseatingly volatile. Too much exposure to this space will cause tears on the next big downturn.

The above are just some of the spaces where yield can be had. Other spaces that we don't own but have yield available include high yield (junk), floating rate loan funds and various parts of the mortgage market.

We only do a little with muni bonds. Individual issues tend not pay too much but of course levered closed end funds pay a lot. We also have TIP exposure but that is not about the yield.

The other really big chunk of the fixed income portfolio is short dated, investment grade corporate debt. Here we use a combo of ETFs and individual issues and the yield is not very good. The more of a fixed income portfolio in this space the less risk that is likely being assumed. The balance between this space and the above categories is of course up to the end user.

By spreading across various segments, versus concentrating 35% in something like emerging markets, there is a chance that not everything will go down at the same time. 2008 was an outlier in this context as markets stopped functioning normally. Diversifying risks by allocating smaller portions to many segments can work when markets function normally. A repeat of 2008 in terms of market ceasing up is a low probability event but large price declines in specific segments are not quite as outlying of an event.

Source: Fixed Income Allocations