ING Investment Management has recently registered 34 Luxembourg-domiciled mutual funds in Hong Kong and is preparing to start rolling them out in mid-May. Although these SICAV funds will be available through ING's financial planning, insurance and private banking arms, the investment management unit will be selective about which ones it aims at Asian institutions and retail investors. First on its list are emerging market debt funds in hard and local currencies.

Rob Drijkoningen, head of emerging market debt fixed-income investments in the Hague, Netherlands, is visiting Hong Kong to assess local institutions' awareness of and appetite for emerging market debt. He concedes it's a tough sell.

"Investors here have a black-and-white story of equities or bonds. It has taken us a while even to get our own insurance people in markets such as Taiwan to invest in non-investment grade debt. And yet investors will invest in local equities markets, which are far more volatile... Investors need more education. Their focus is either Asia-only, or investment grade. To get them to invest in global sub-investment grade is still a step too far."

On the plus side, ING's hard and local currency EMD funds have a track record already, which makes them easier to market. ING believes this is an attractive, niche product for retail investors, and is in discussions with potential distributors in Hong Kong. It also plans to register the SICAVs in Singapore. The firm now manages around $600 million in local currency EMD and $4.4 billion in hard currency EMD, of which $2.9 billion is below investment grade.

Drijkoningen argues that EMD is attractive for several reasons, despite the prospect of rising US interest rates. The major emerging market borrowers' fundamentals are vastly improved over 1994, the last time emerging market debt enjoyed a major bull run. For example, today the governments of Argentina and Brazil are running current account surpluses, while emerging markets have reduced foreign debt and, particularly in Latin America, developed local capital markets.

The big attraction to EMD is its low co-variance with traditional asset classes. From 1998 to 2003, EMD, both in local currencies and among hard-currency issues, has enjoyed a very low or negative correlation to US treasuries, high-yield debt, global bonds or emerging market equities. Returns on the asset class have also been high, despite a series of unfortunate events, such as Russia's 1998 default, the devaluation of the Brazilian real, and Argentina's default in 2002 " headline events that Drijkoningen says obscure the steady pace of mundane but good news.

Nonetheless, EMD has enjoyed five good years not only because emerging markets are in better shape, but because the United States has kept interest rates at 45-year lows, creating a steep yield curve and an easy carry trade for emerging market debt investors. Is the EMD game up if the Federal Reserve begins to raise interest rates " particularly if those raises are faster than expected?

"Our exposure is tilted toward the long end of the yield curve," Drijkoningen says. "If the Fed doesn't raise interest rates too much, the long end of emerging market countries' curves could be supported."

More important, he believes the advances in emerging markets' balance of payments means that EMD has become a legitimate asset class of itself, thanks to its low correlation to other asset classes. Many emerging markets are experiencing credit rating upgrades.

"We're very far away from a situation where the Fed tightens rates and Mexico gets the tequila crisis," he says. "Sovereigns are reducing their debt, and the rise in local currency funding is due to corporate borrowers. Mexico hardly issues in dollars anymore. It's the same for Poland, where local pension funds have become the main buyers of local currency issues."

Asian markets are seriously behind, however, when it comes to weaning off international capital and developing their own bond markets. Drijkoningen says Asian countries' continued reliance on bank financing is hurting local borrowers' access to cheaper financing, and reducing the market's ability to impose discipline or promote good corporate governance.

"Mexico, on the other hand, is totally open," he says. "Korea, for example, could really enhance its capital market. But Asian countries are still afraid of being ruled by foreign capital."

For this reason, ING's EMD funds are underweight Asia, with overweight positions only in Indonesia, and neutral Malaysia and the Philippines. Most of its risk is in Latin America and Russia. That could change, however, if the Fed raises interest rates, which would prompt Asian central banks to follow suit " but not in Latin America, where such a move would threaten fragile economic recoveries in Brazil and elsewhere. In that event, ING may switch some exposures out of Latin America, to Asia and Eastern Europe.