By Ben Levisohn

Last year, emerging market bonds were one of the best performing asset categories. This year, theyve offered little more than disappointmentespecially for those invested in the bonds denominated in U.S. dollars .

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How badly have they done? The iShares JPMorgan USD Emerging Markets Bond (EMB ) exchange-traded fund, which tracks the dollar-denominated JPMorgan EMBI Global Core Index. has lost 2.5% this year, after returning 17% in 2012.

Forget all the talk of an emerging-market bond bubble. however. Part of the loss is due to the fact that the bonds closely track U.S. Treasury yields because theyre issued in dollars. So with Treasury yields rising and prices fallingthe iShares Barclays 7-10 Year Treasury Bond ETF (IEF ) has dropped 1.3%, for instanceemerging market bonds have also taken a hit. And the difference between the yields on emerging-market bonds and equivalent Treasurys has also increased, says J.P.Morgans Joyce Chang in a report released this week.

Investors shouldnt be worried, however, Chang says. She believes U.S. Treausry yields have moved too quickly, and will fall in the months ahead. Ultimately, dollar-denominated bonds could return 5% to 6% for the remainder of the year, she says.

Still, investors might be better off with bonds denominated in local currencies, Chang says. They should return between 8%-9% this year, with gains from both foreign currency and coupon payments. She also recommends increasing exposure to higher-yielding credits, like Venezuela. Angola. Gabon. Georgia. Dominican Republic. Indonesia and Sri Lanka. She also prefers high-yield corporatesincluding the debt of Venezuelas PDVSA. and Brazils Vale (VALE ) and Petrobras (PBR ) to investment grade ones.

Of course, those bonds are high yield for a reason and they come with more risks than investors might be used toespecially if the recent drop in the dollar denominated bonds has proven too anxiety provoking. If thats the case, best to stick with a nice, plain vanilla ETF  like MarketVectors Emerging Markets Local Currency Bond ETF (EMLC ), which tracks the JPMorgan GBI-EMG Core Index. Its gained 0.35% this year after gaining 14% in 2012.

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