Emerging market debt (EMD) is often seen as a risky asset class however it has changed over the years. Last year I wrote an Innovation on emerging markets (EM) and the reduction in equity volatility vs developed market (DM) equity markets. But I also talked about emerging market debt and its attractiveness as a sub-asset class, not just for performance but for diversification benefits too.
Some factors I raised which still ring true today are geopolitics, currency, and diversification. As we have seen in the past year DMs can be just as volatile and unpredictable. The US has dominated geopolitics and put itself at the centre of global economics. US volatility, US bond downgrades, and dollar weakening have been very important for emerging markets, and particularly EMD.
Currency in EMD can be hard or local. The most common hard currency is USD hence its importance. For reference, the JP Morgan Hard currency sovereign index has returned over 5% YTD, JP Morgan Local currency sovereign index has returned over 10% YTD and the JP Morgan Corporate index has returned around 4% YTD. It matters how you get exposure.
This year has been a volatile year geopolitically – from US tariffs to the escalation of conflict in the Middle East. Uncertainty around the US has caused some markets and some parts of the market to be more volatile, but also more generally has seen a shift in thinking by investors to diversify away from the US. Quite a few emerging markets are distanced from US tariffs compared to others. China seems to be the main target with the US having a large trade deficit with them. Places in South America have been more sheltered as they have a much smaller trade surplus with the US, including Brazil, Colombia, and Argentina.
Following this we have seen a weakening in the US dollar. Once a safe haven asset this is now being called into question. The dollar since the start of 2025 has fallen around 10% against a basket of currencies which is quite a meaningful weakening and is the worst H1 for the currency since 1973. EMD is closely intertwined with US dollar performance as it is the main hard currency used. Despite the currency headwind the hard currency index has still outperformed US treasuries and UK gilts, which performed just over 3% YTD and just over 2% respectively. But it was local sovereigns which have had a strong 2025 so far.
Local sovereign outperformance has come from either currency moves or interest rates and US volatility. Many EM countries are in a different part of the rate cycle due to sensible and tough central bank decisions to increase rates quicker and more aggressively vs DM central banks when rates increased in the wake of Covid. So as rates come down and inflation in these countries becomes more stable local EM debt has done well. In for example, Brazil, South Africa and India. Local ownership of local currency bonds has been increasing as the percentage of foreign holdings have been decreasing and has exceeded $5 trillion in tradable debt making local currency debt an extremely tradable market.
Reform stories are often an important part of EMD performance. A key one this year has been Argentina with an IMF package, increase in exports, and new deregulation laws. Central bank reserves have increased and its currency has had limited volatility.
Diversification in the EMD market has helped in 2025. Diversification of countries, currency, and the mix between sovereigns and corporate debt. As we have seen local sovereign debt has had a stellar performance in 2025 so far and I do think this will continue. Speaking to some EMD managers, all are seeing more attractive opportunities in the corporate EM debt market than ever before. For reference this will still be a limited part of their portfolio. For example, an EMD fund we spoke to has 35% in corporate debt, which is the highest allocation they’ve ever had to this part of the market. Another fund we spoke to has a maximum corporate weighting of 15% and the fund was sitting at 14% so this signals high conviction and opportunities in the space.
Overall it’s a similar story to what I said last year which is don’t put 100% in EMD but it certainly deserves a place in portfolios where appropriate and is seeing more attractive opportunities as uncertainty and volatility increases elsewhere.
Emily Cave – Research Analyst
FPC25445
All charts and data sourced from FactSet
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