Last week, the pound sterling soared to a 26-year high against the dollar and the euro hit its own two-year peak. You can imagine retail investors across the U.S. were anxiously wondering whether they'd put enough of their savings in assets abroad, even with the Dow's crowd-pleasing performance.

Meanwhile, a bold group of investors were probably feeling validated, yet again. These are the managers who've snapped up local currency paper in emerging markets over the last few years, often taking it unhedged.

By just holding on and clipping coupons, some have made a killing.

Case in point: bondholders in Brazil. Last week, the real reached its highest value against the dollar since March 6, and it had gained 74% since President Luiz Inacio Lula de Silva took office in January 2003, for the first of two terms.

A high-quality bond in Brazil delivers double-digit returns in local currency, in part reflecting higher inflation, but largely because of steep domestic interest rates. For any dollar-earning investor with the luck or foresight to buy a Brazilian bond a couple of years ago, the formula's been simple: Double-digit returns + appreciation against the dollar = ear-to-ear grin.

But for how much longer? Past performance, as the financial literature is obligated to remind us, is no guarantee of future results.

One thing to keep in mind is that the dollar doesn't have to weaken for U.S. investors to fall, and stay, in love with local currency paper. With rates as high as, say, Brazilian levels, the greenback could even strengthen a bit, and dollar-based investors would still rake it in.

More and more buy-siders, it seems, have cottoned on to this.

"Local currency deals are going to be increasingly important as a percentage of [EM trades]," said LatAm pro Gordon Kingsley.

This, despite stubborn hurdles. Regulatory and tax issues in the region ratchet up the costs for foreign investors to buy domestic. Brazil, again, serves as an example. Taxes there have inhibited some investors from coming in, said Merrill Lynch's managing director Mike Lucente. Knock down that hurdle, and foreign flows, he said, could "grow exponentially."

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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