By Charles Gélinet, co-portfolio manager of the J. Stern & Co. Emerging Market Debt Stars fund
Emerging market hard-currency corporate bonds, overlooked by many investors despite being almost twice as big as the US high-yield market ($2.5trn v $1.3trn), held up remarkably well in 2025 – a year of economic and political uncertainty.
The heightened uncertainty caused by Liberation Day came and went. Emerging market corporate credit spreads (a proxy for credit risk) initially widened, but the dust soon settled and spreads tightened back to pre-Liberation Day levels as the year progressed. Overall, the direct impact from tariffs was modest, with most regions and sectors affected more indirectly through slower growth and currency volatility.
From a regional perspective, Asia was the most vulnerable, with China in the crosshairs of President Trump. Latin America was more complex, with Mexico being the obvious target for tariffs. However, many companies are now better placed than previously, with a share of non-US revenues having increased and established operations in the US, which mitigates tariff risk.
The asset class’s performance over this period highlights a broader message. Based on 20 years of VIX data, the relative outperformance of emerging market hard-currency bonds during periods of intense volatility is significant. In most cases, the drawdown has been less than 40% of that witnessed in US equities, thereby providing downside protection.
The risks associated with emerging market corporate bonds are often perceived to be greater than they actually are, as they are frequently associated with EM sovereign debt. Indeed, its resilience is hard for people to imagine. In reality, the risk profile is primarily driven by companies’ fundamentals.
A company with strong competitive positions and predictable cashflow is well-positioned to repay debt, regardless of its location. This helps explain the strong returns of the asset class, with emerging market high yield generating more than 8% on an annualised basis over the past two decades. Second only to US equities in liquid risk assets at +10.0%.
The year did not pass by without some jitters, however. With interest rates persisting at higher levels for longer than expected, markets were surprised by unexpected defaults in the broader corporate sector, particularly in US private credit, with the high-profile bankruptcies of Tricolor and First Brand. The question that haunts investors is whether we are at a late stage of the credit cycle and about to experience a pickup in default risk across the spectrum. The data on emerging market corporate debt suggest otherwise.
We generally compare emerging market corporates with their US peers. Looking at the leverage metrics, both emerging market and US corporates have seen a marginal weakening in their debt-to-EBITDA ratios, albeit from a strong base. From a relative perspective, emerging market corporates are less leveraged than their US counterparts. Similarly, both US and emerging market corporates have seen a slight decline in cash balances, albeit emerging market corporates maintain over twice the liquidity of US firms.
This positions them better to defend their businesses and service debt. These strengths are evident in default rates. EM corporate high yield defaults peaked in 2022-2023 due to localised factors in Russia and in China’s real estate, which are now subsiding. As a result, default rates are returning to the long-term average of about 3%.
It is also important to compare this default rate trend with other areas where investors are active, such as European high yield and private credit. For European high yield (excluding Eastern Europe), default rates have been similar to emerging market corporates, with a baseline forecast of around 3%. A more favourable interest rate environment in Europe could further ease refinancing pressures.
Comparing private debt default rates is more difficult, primarily because of the opacity of this illiquid asset class and the widespread use of Payment in Kind (PIK) arrangements, which can delay potential defaults. Historically, private credit defaults have been assumed to be very low (< 1%), but recent data and S&P’s analysis show that, when “selective defaults” are incorporated, the overall default rate is about a third higher than that of emerging market corporates.
The year ahead
We remain cautiously sanguine about 2026. Growth is forecast to remain at similar levels to 2025, supported by fading tariffs risk and easing monetary policy. Emerging markets are likely to be the core driver of this growth, and countries’ debt metrics are more benign than parts of the developed world. We’ve also seen a trend of fiscal and monetary prudence in these regions. We see the key risks as macro-related, with inflation trending higher and implications for the Federal Reserve’s interest rate decisions.
Emerging market corporate bonds offer a compelling investment case, with attractive all-in yields supported by the repricing of underlying interest rates in 2022/23. The sub-investment-grade universe offers high single-digit yields, which are a good indicator of total returns over the coming years.
Credit spreads should be anchored to a degree by resilient underlying corporate fundamentals, and default rates are expected to be in line with historical averages. Companies have been proactive in managing their balance sheet, reducing the debt maturity burden and refinancing risk in 2026. Technicals should also be supportive as investors look to emerging markets for diversification benefits.
Our current short-duration strategy (of around 2.5 years) also provides protection if credit spreads widen. Short-dated bonds should also perform better if interest rates do not fall as quickly as some investors are expecting. In our experience, adding it to a global equity portfolio reduces volatility materially without significantly sacrificing returns with the added benefits of diversification.
