Aug. 21 (Bloomberg) -- Thomas Cooper’s emerging-market bond fund fell 33 percent last year when bonds from Argentina, Venezuela and Ukraine plunged during the financial crisis. The fund gained 30 percent this year as investors regained an appetite for risk, bidding up those same bonds.

Cooper, co-manager of the $2.1 billion GMO Emerging Country Debt Fund, said he favors the hardest-to-sell, highest-yielding bonds because their rewards more than make up for their risks.

“A country may be a disaster, but if the price is low enough, we will buy the debt,” Cooper said in a telephone interview.

GMO Emerging Country Debt returned 15 percent annually for the 10 years ended in July, the best performance among 40 emerging-market bond funds, according to Morningstar Inc. The JPMorgan & Co.’s EMBI+ index returned 12 percent a year in the same period.

Michael Herbst, an analyst for Morningstar in Chicago, said the fund’s willingness to hold debt from “dicey” countries such as Venezuela means results will suffer in volatile markets.

“The fund took it on the chin last year,” Herbst said in a telephone interview. The financial crisis, which started with the collapse of the U.S. property market in 2007, sent the global economy into the first recession since World War II.

The Massachusetts state pension system fired the fund’s manager, Grantham, Mayo, Van Otterloo & Co., in April from overseeing $230 million in emerging-market debt, citing poor performance. The pension was a shareholder in the mutual fund.

Wrong Bets

“Every bet we made last year turned out to be wrong,” Cooper said. The fund suffered as investors sought safer securities last fall, he said.

GMO manages $89 billion, according to the Web site of the Boston-based firm. It is best known for its chief investment strategist, Jeremy Grantham, who was bearish on U.S. stocks for much of this decade.

Cooper and William Nemerever have run the Emerging Country Debt Fund since 1994. The fund requires a $10 million minimum investment and is sold to institutional investors. The two managers oversee $4 billion in mutual funds and hedge funds.

Cooper, 52, has a bachelor’s degree from Oberlin College in Oberlin, Ohio, and a master’s degree in business administration from the University of California, Berkeley. Nemerever, 62, has a bachelor of science from the University of Washington in Seattle and a master’s degree in actuarial science from Northeastern University in Boston.

Bond Investments

The fund invests in the debt of countries and companies that are closely linked to governments such as Gazprom, a Moscow-based energy producer. Those bonds, called quasi- sovereigns, offer higher yields than government debt with little extra risk, Cooper said.

The fund seeks higher returns by buying bonds that are more difficult to sell than better-quality debt. They can include smaller issues or bonds denominated in currencies other than the U.S. dollar, Cooper said.

“If you are a buy-and-hold investor like we are, it doesn’t make sense to pay up for more liquid assets,” he said.

The extra yield investors demand to hold emerging-market bonds instead of U.S. Treasuries rose from 242 basis points to as much as 865 basis points from May 29 to Oct. 24, JPMorgan data show. The gap has since closed to 381 basis points. A basis point is one-hundredth of a percentage point.

Widening Yield

A widening yield over Treasuries means investors are more concerned about the potential for default.

“The collapse in spreads this year was justified given the reduction in risks,” said Nick Chamie, head of emerging-markets research at RBC Capital Markets in Toronto. Further declines in spreads are unlikely for now, Chamie said.

Argentine bonds yield 926 basis points over Treasuries, down from 1,960 in March, JPMorgan data show. The GMO fund’s largest position as of May 31 was an Argentina bond in euros that matures in 2038, according to Morningstar’s Web site. The bond represented 6.2 percent of the portfolio.

Argentine bonds represent “good value,” said Cooper, because investors are overly concerned about a government default. The nation halted payments on $95 billion of debt in 2001, the biggest sovereign default in history. In the event of a default, the price of Argentine bonds probably would not fall dramatically, Cooper said.

‘Slowly Destroying’

Venezuelan dollar-based bonds that mature in 2023 represented 3.2 percent of the fund’s portfolio in May, Morningstar data show. Cooper said Venezuela’s president, Hugo Chavez, is “slowly destroying” the country’s economy through misguided policies. The 2023 bond yields more than 14 percent, Bloomberg data show.

The fund’s third-largest holding in May, accounting for 4.9 percent of the portfolio, was a Ukrainian bond in Swiss francs that matures in 2018. The bond has a put option that would allow him to sell it back at face value in mid-September. Cooper plans to exercise that option in response to the country’s “deteriorating” political situation.

Political deadlock among President Viktor Yushchenko, Prime Minister Yulia Timoshenko and the parliament before January elections is hampering an economic recovery. Ukraine’s economy shrank at an annual rate of 18 percent last quarter.

To contact the reporter on this story: Charles Stein in Boston at cstein4@bloomberg.net.

Last Updated: August 21, 2009 00:00 EDT