Last year was a difficult one for investors in emerging market bond funds. The question investors asked themselves was whether emerging markets would experience a sharp correction or would continue to reflect improved fundamentals in the developing world. Pioneer's Emerging Markets Bonds Fund took a defensive position, with a high level of liquidity, during the year. External debt underperformed local markets but outperformed corporate debt and the fund's flexibility to invest in all paid off, leading to a return of 7.9 per cent. 'Our performance was helped by our exposure to the local markets,' said Yerlan Sysdykov, lead manager of the fund. 'However, it suffered from our exposure to the corporate markets, which sold off in sympathy with the general credit markets. At the end of the year we took profits in local markets and our exposure now is reduced. Our positions in corporate markets have a combination of high carry and good potential to bring capital gains in 2008.' The fund was bearish on Venezuela, which showed a significant deterioration in management of the economy in spite of strong markets for oil - its main export and economic driver, according to Mr Sysdykov. 'Our overweight positions in Russia and Brazil, both in local and external debt, helped us to outperform the market. Our position in Turkish local markets gave a significant boost to performance as well,' he added. In terms of industries, the fund's positive performance was driven by commodities exposure from gas in Russia, iron ore and beef in Brazil and palm oil in Indonesia. In countries experiencing a consumer boom, the fund was exposed to retail, and in Russia and Ukraine to telecommunications and the banking sector. 'Event risk was significant in the wake of bearish credit markets in the second half of 2007,' said Mr Sysdykov. 'We continued allocating our funds to the more defensive strategies, such as short-term corporate exposure and local markets, which helped retain most of the performance we achieved in the first half of the year.' Investors who believed in stronger fundamentals in emerging markets were right to do so, according to Mr Sysdykov. In previous boom-bust cycles, local markets typically performed worse than external debt, given low liquidity and shaky fundamentals. 'This time it was different. First of all, the correction was moderate, and performance of the local markets was even stronger than external debt,' he said. 'Our analysis allowed us to believe in the benign scenario and continue to keep our bets in local markets, which turned out to be the right strategy.' The fund's investment split on February 29 this year was 39.1 per cent in government/agency bonds and 57.5 per cent in corporate bonds. Its largest investment, 15.2 per cent of the portfolio, was in Russia. The remainder of the portfolio was split 11.2 per cent in Turkey, 7.9 per cent in Venezuela, 7.8 per cent in Argentina, 7.1 per cent in Brazil, 5.4 per cent in Kazakhstan, 4.5 per cent in Mexico, 4.4 per cent in Indonesia, and 36.5 per cent in other countries. Pioneer's emerging markets global debt fund manages more than US$1.1 billion of assets. According to Mr Sysdykov the fund's flexibility to invest not only in external debt, but also in local markets and corporate debt, makes it an attractive proposition for investors. Looking ahead at the remainder of 2008 Mr Sysdykov remains positive on the outlook for emerging-market debt. 'The perceived risk of investing in emerging-market debt has declined significantly since the long-term credit market crisis at the end of 1998. This reflects the dramatic improvement in the macroeconomic backdrop of emerging-market economies,' he said. 'The spread required by investors over 10-year US Treasury bonds is close to its lowest level pointing to a systemic credit quality improvement over the period. Spreads continue to tighten which helped emerging-market bonds post an uninterrupted series of positive returns over the past decade, significantly outperforming global bonds and even high-yield bonds more recently.' There are, however, new risks to contend with. Unlike previous years, where specific risks in emerging markets were typically substantially higher than the global ones, the picture is different today, according to Mr Sysdykov. 'Global economic conditions remain worrisome, given the evidence that the US economy is showing signs of slipping into recession,' he said. 'A continued slide in the value of the dollar may put pressure on global financial markets. Financial markets' continued inability to provide liquidity and correctly price the risks may cause significant volatility and market dislocation.' Politics, an old bugbear of emerging markets, is also back. 'Certain countries are entering a period of power shifts, where we may see the progress in economic policies being slowed or outright reversed. This will change investor sentiment to emerging markets, which may lead to a negative performance of the asset class.'