Ways To Play
If you can grit your teeth and bear the news from overseas, there are many different ways to play the market, according to your temperament. The biggest debates are whether you should be in the local currencies or in U.S. dollar denominated issues. If you stay with the former, you've got a lot of volatility (and a queasy stomach). If you stay with the greenback, you risk the deflation of the U.S. dollar against these raging tiger countries and their domestic success stories.

Padilla at DoubleLine said in her Web cast that her firm is looking at emerging market corporates denominated in U.S. dollars, and she claims that local currencies are too volatile for her team. "The emerging market corporate index, which is denominated in U.S. dollars, and the local currency emerging market government bond index both delivered over 13% returns in 2010," she said, but added, "The volatility of the local currency emerging market bond index was over four times that of the emerging market corporates."

She also points out that Indonesia and Brazil have taken measures to stop their currencies from strengthening. "As a result of these measures, we believe that currency appreciation could be capped, thereby limiting the potential for total return from these investments."

Padilla said her firm is finding opportunities lower down the risk band. "Emerging market corporates are restoring their balance sheets by reducing their leverage ratios," she said. "These credits, when we compare them to their U.S. comparably dated companies, have lower leverage ratios across all rating categories. We took 200 companies and divided them into three rating categories, triple-B, double-B and single-B. And we note that the leverage for all of the rating categories is lower for emerging market corporates than for their U.S. counterparts." She says that some emerging market companies rated double B actually had less leverage than U.S. triple-B's.

While Padilla is wary of sovereign bonds, Michael Cirami, a vice president and portfolio manager with the global fixed income team at Eaton Vance, loves them. He says that right now he's looking mostly at sovereign plays in local currency rather that corporates-auguring, like other managers, that the appreciation of local paper money will outstrip the wilting lettuce known as the U.S. dollar.

"In 2011, we think really the opportunities in that space are in the local debt," says Cirami. "And here the call is really the currency valuations. When you look at the world and you see the problems that we have today and some of the imbalances out there, the correcting of these balances is one that calls in our mind for strength to emerging market currencies. And one of the best ways to play this is in the local debt."

A persistent worry about these local currencies is that global inflation will eat into that sweet currency yield. Some countries also seem determined to keep their currencies capped so that developed countries will still buy their goods cheap. Cirami thinks inflation would actually be a good thing for local currency bonds because it will force central banks to tighten up their monetary policy to keep their moneys strong.

"We think that the central banks in the emerging market space are going to want to keep the gain in credibility that they've had through fighting inflation over the last decade and not be too complacent," he says.

Among the currencies he likes are those in the Czech Republic, Poland, Israel, Kazakhstan and Serbia. He's also bullish on the currencies of Brazil and Indonesia but not as much as he is on the economies themselves. "I would say that there is a little bit of that disconnect and we're more bullish on the fundamentals of the economy than on the currency," he says.

MacKay Shields' Howard Booth, meanwhile, likes both corporates and local currency bonds within Brazil and Mexico for their higher yields and moderate volatility. "In addition, there's a couple of Asian currencies that I feel are attractive," he says. "I like the Philippines' local bond side. My preference is to be in the middle to short end of the market because a lot of emerging markets that have less idle capacity are being challenged with increasing inflationary pressures. We are watching closely to see if the central banks generally are willing and able to stay ahead of the curve."