Managers from Pictet, HSBC, Nedgroup and Morningstar have argued the opportunity set in emerging market debt has become increasingly appealing, despite going under the radar for investors.
For Shaniel Ramjee, multi-asset manager at Pictet Asset Management, the case for the asset class could have much further to run, despite outperforming developed market local debt over the past five years.
“A bull market in EMD has started; I’m just not sure many investors have realised it,” he told Portfolio Adviser.
Part of this is due to the increasingly attractive comparisons with developed market debt, which have looked more unstable as bond yields have risen across the UK, Japan and the US in recent months.
Ramjee noted that high levels of deficit in the developed world are behind some of this trend.
Government deficits remain high across developed market economies according to recent data from the International Monetary Fund (IMF), with the US, UK and Japan all having net debts of above 100% of GDP.
See also: DNCA CIO: Global fiscal deficit fears are overdone
“Ultimately, we have a situation where sovereign bonds in the developed markets are starting to come under pressure because the debt levels of developed markets are simply that high,” Ramjee said.
“The refinancing that’s required to keep developed market governments funded is so large, and the government spending that is happening is not all that productive.”
As a result, central bank credibility has come under fire and keeping inflation at target has been challenging in developed markets.
“The question then is, to what extent are bondholders going to get paid back on the money they’re lending,” Ramjee asked.
By contrast, emerging market debt looks relatively safe, with clean balance sheets and often much lower deficits.
Mike Coop, CIO at Morningstar Wealth, said: “I think it’s relatively underappreciated in emerging markets just how much things have improved, both relatively and in absolute terms.
“Institutionally, many EM countries are run much better than they used to be, whether that’s in terms of debt, monetary policy, or institutions, while we’ve seen some backsliding on that in areas like the US.”
Pictet’s Ramjee added that emerging market currencies have become more stable over time, having just slid around 3% in the immediate aftermath of the Iran conflict, a significantly better result than the 2022 bear market when they slid about 10%.
“You can see that resilience building as they’ve been getting stress tested and that’s going to create much more demand for those bonds,” Ramjee said.
See also: What does 2026 hold in store for emerging market debt?
Alongside this relative safety, EMD is also offering some increasingly attractive yields, according to experts.
“Inflation has also generally been well managed, meaning these bonds can offer attractive real yields, making this area a valuable diversifier within portfolios,” Madhushree Agarwal, portfolio manager on the multi-manager team at Nedgroup Investments, said.
Nick McLoughlin, multi-asset portfolio manager at HSBC, added that EM countries were the earliest to hike rates post-pandemic, which meant they were much faster on the tightening cycle, bringing in a “degree of inflation credibility”.
‘Don’t treat the asset class like a homogenous blob’
That said, experts also agreed there were still challenges to the asset class, not in the least from wider geopolitics.
As Nedgroup’s Agarwal noted, the asset class has benefited from the weaker US dollar, which has reduced borrowing costs and supported debt sustainability. As a result, experts noted a return to dollar strength could be a headwind.
“The big risk here is of course the dollar; that view is only high conviction in the sense that the dollar remains weak,” HSBC’s McLoughlin said. On top of this, while fiscal discipline in EM looks better than developed markets, in some areas it was still “not brilliant”.
As a result, it was critical to remain selective in emerging market debt.
“You can’t treat the asset class as a homogenous blob; there’s a lot of dispersion within it,” he said. “The dynamics in, say, Korea are very different to India or Brazil.”
For the HSBC team, Brazil was an area of interest. Currently, it has around a 15% interest rate, which means that even if investors are pricing in higher inflation from the ongoing geopolitical conflict, “you’re talking 5%, even 10% real yields, much higher pickups than what you get in DM”.
“It’s a good level of carry and received interest, on a stronger currency with less of the worries than you saw a decade ago,” according to McLoughlin.
Pictet’s Ramjee has agreed that selectivity is important; he also said there were plenty of interesting opportunities.
“Even somewhere like China, which has really low real yields, is a tremendous diversifier for a portfolio when global bonds have been very volatile,” he said.
As Nedgroup’s Agarwal noted, return drivers in EM are “far more local and policy specific”, which lets these bonds offer genuine diversification.
“The asset class is full of high yielders, giving you a great return and good diversifiers,” Pictet’s Ramjee noted. “They are a fantastic addition to portfolios.”
See also: JPMAM’s Papp: Time to revisit emerging market debt
