�۶���Ƶ

Over the last decade, emerging market (EM) hard-currency and local currency debt have grown significantly. We believe default rates have peaked for EM sovereigns and corporates which should be a tailwind for performance. EM hard currency debt has outperformed similarly rated US corporate debt year-to-date in 2025, including during and after the tariff announcements.

Relative valuations versus other fixed income sectors are attractive in EM high-grade and high-yield and that has driven strong crossover interest in the sector, which we expect to continue. Positive technical factors could provide additional tailwinds to returns.

Over the last decade, emerging market (EM) sovereign hard-currency debt has approximately doubled in size from around USD 700 billion in the early 2010s to USD 1.4 trillion now according to data from JPMorgan. Emerging market corporate hard-currency debt has grown at an even higher rate and is now at USD 2.5 trillion. Just over half of this debt is rated investment grade.

Over the same time period, EM local currency debt for sovereigns and corporates has grown to become the dominant segment of EM debt as shown below. The JPMorgan GBI-EM Index (Local Currency Debt) has become more representative of the investment universe with China and India being added in 2020 and 2024 respectively.

Figure 1: EM fixed income market

Bar chart showing the size of various global bond markets segmented as corporate credit, emerging market fixed income, government ebt and US fixed income and structured, in USD trillion as of December 2022. The largest market is US Treasuries at USD 28.3 trillion, followed by developed market sovereigns at USD 16.6 trillion, and EM local sovereigns at USD 13.3 trillion. Other categories include US investment grade (USD 8.5 trillion), US high yield (USD 1.3 trillion), euro IG (USD 3.2 trillion), euro HY (USD 0.4 trillion), EM hard currency corps (USD 2.5 trillion), EM local corps (USD 11.6 trillion), EM hard currency sovereigns (USD 1.4 trillion), munis (USD 4 trillion), agency debt (USD 1.5 trillion), agency mortgage-backed securities (USD 9 trillion), non-agency MBS (USD 0.7 trillion), asset-backed securities (USD 0.7 trillion), collateralized mortgage-backed securities (USD 0.7 trillion), agency CMBS (USD 1 trillion) and Collateralized loan obligations (UAD 1.1 trillion).

Through this period, emerging market economies, including frontier countries, have on average grown by more than 4% and companies domiciled in these countries have generally benefited as well. This growth has not been achieved solely through increased government spending. As per IMF data, net government debt on average for advanced economies is above 80% while for emerging and middle-income economies it hovers close to 45% as shown in figure 2.

Figure 2: Government net debt forecast

Line chart showing government debt as a percentage of GDP from 2014 to 2028 for developed economies and emerging market and middle-income economies. developed economies start around 75% in 2014, peak near 90% in 2020, and is expected to stabilize around 85% by 2028. Emerging market and middle-income economies start at 25% in 2014 and is expected to rise to nearly 50% by 2028.

When looking at historical returns generated from underlying investments, it is perhaps helpful to look at the Sharpe ratio – an objective metric for risk-reward, which expresses how much excess return is received for the volatility of holding a riskier asset. Using data from 2003-2024, the return profile for hard currency emerging market debt within sovereigns and corporates is significantly above that of sovereign debt issued by the US, other developed market sovereigns and US investment grade companies, even during a period that includes US exceptionalism.

Figure 3: Sharpe ratios

This chart compares the return, risk, and Sharpe ratio of various asset classes. EM sovereign bonds have a return of 6.57%, risk of 8.37%, and Sharpe ratio of 0.78. EM corporate bonds offer a return of 5.89%, risk of 5.22%, and Sharpe ratio of 1.13. EM local bonds have a return of 5.31%, risk of 10.68%, and Sharpe ratio of 0.50. US IG bonds provide a return of 4.35%, risk of 6.13%, and Sharpe ratio of 0.71. US high yield bonds have a return of 7.59%, risk of 7.59%, and Sharpe ratio of 1.00. US Treasuries offer a return of 2.72%, risk of 4.55%, and Sharpe ratio of 0.60. non-US DM sovereigns have a return of 2.44%, risk of 6.93%, and Sharpe ratio of 0.35. The S&P-500 index shows a return of 11.93%, risk of 17.15%, and Sharpe ratio of 0.70. The MSCI World index has a return of 8.37%, risk of 16.98%, and Sharpe ratio of 0.49.

We believe default rates have peaked for EM sovereigns which should be a tailwind for performance. The wave of defaults due to the pandemic and the Russian invasion of Ukraine is behind us: there have been no sovereign defaults since the end of 2023, and we do not currently anticipate any material sovereign defaults in 2025. Corporate defaults have also been decreasing over the last couple of years. The outlook from credit rating agencies for emerging-market debt has become more positive than negative, with ratings upgrades on an improving trajectory as shown below, and we even have a few ‘rising stars’ in sovereign markets; these are credits that are expected to receive at least two out of three investment grade ratings with Oman and Azerbaijan being recent examples.

Figure 4: Favorable credit ratings and fewer defaults

Two charts related to emerging market (EM) credit rating actions and defaults. The left chart shows the percentage of upgrades as a share of total rating actions (rolling 6-month average) from March 2020 to June 2025, highlighting a large proportion of downgrades during 2020, followed by a period where upgrades outnumber downgrades. The right chart is a bar graph displaying annual default counts for US high yield (HY), CEMBI broad HY, and EM sovereign HY from 2008 to a forecast for 2025, with notable spikes in defaults during events such as the Argentina technical default (2014), Ukraine default (2015), idiosyncratic country defaults (2020-21), and the Russian invasion of Ukraine (2022).

EM hard currency debt has outperformed similarly rated US corporate debt year-to-date in 2025, including during and after the tariff announcements. EM currencies have held up well vs. the dollar, which may provide EM central banks with leeway to cut rates aggressively to manage potentially lower growth. Emerging markets outside Asia generally avoided high reciprocal tariffs even before the 90-day extension. We believe debt issued by Asian countries should be supported by their strong external position and lower oil prices, as most Asian countries import oil, and lower prices should help offset the impact of tariffs. We believe most of the Asian countries targeted with initial high reciprocal tariffs also have fiscal room to help mitigate any impact on growth.

EM sovereign and corporate debt indices, unlike equity indices, are constrained at the country level. As of end-June 2025, Saudi Arabia has the largest weight in the JPMorgan EMBI Global Diversified index at 5.17% followed by Mexico at 4.93%. Equivalent country exposures for the JPMorgan CEMBI Broad Diversified index stand at 6.38% for China and 5.08% for Brazil. This relatively low country concentration risk contrasts with global equity portfolios, which have massive exposure to US stocks, and global emerging markets equity portfolios tracking the MSCI Emerging Markets Index, which have over 80% exposure to stocks in China, Taiwan, India, South Korea and Brazil.

Further, frontier countries such as Argentina, Egypt, Nigeria, Ukraine, etc., are now part of the debt indices accounting for 26% in the JPMorgan EM sovereign debt index and almost 12% in the JPMorgan EM corporate debt index.

We believe relative valuations vs. other fixed income sectors are attractive in EM IG and EM HY and that has driven strong crossover interest in the sector, which we expect to continue. Yields are in the top quartile of a fifteen-year trading range, so returns in the high single digits over the last couple of years and year-to-date 2025 for HC EM sovereign and corporates are attractive.

If the dollar stabilizes, or weakens, and if policy rates decline globally, as expected, it may provide EM debt with important tailwinds over the coming years. Such conditions have not existed over the last decade or so and could be an important driver of flows.

In addition positive tail risks may emerge over the coming year. Easing of tariffs, reduced geopolitical tensions or negotiation of ceasefires as well as continued stabilization of growth in China would be very positive for EM assets. In such an environment, we believe EM sovereign and corporate dollar denominated debt is likely to continue to perform well. Local currency debt may also perform well over the long term though there could potentially be periods of dollar strength that could generate volatility.

Despite the uncertainty of potential tariffs, we believe growth prospects for countries such as Mexico and Poland are likely to improve, led by a pickup in near-shoring and friend-shoring activities and in foreign direct investments as businesses adjust their global supply chain strategies. According to IMF forecasts, growth in emerging markets is still expected to be stable around the 4% mark as shown in the figure below, despite a projected slowdown in US growth.

Growth in China, at over 5% in first-half 2025, has been pretty strong despite the trade war, but even during last couple of years of slower growth in China commodity prices have been trading in a higher range and are likely to remain so over the coming years due to supply constraints and demand from decarbonization; this should benefit EM countries which are commodity exporters: more than 60% of the countries in the EM sovereign hard currency index are commodity exporters.

Figure 5: EM-DM growth differential

Bar and line chart showing annual GDP growth rates (%) for developed markets (DM) and emerging markets (EM) from 2013 to 2026F. The chart highlights that EM consistently outpaces DM in GDP growth, with notable dips for both in 2020 due to the pandemic. Projections for 2025 and 2026 indicate continued higher EM growth and a stable differential.

Policy uncertainty in the US has led to an increase in flows into EM funds over the last several months which we think will be an important technical driving performance. EM external debt net issuance for sovereigns and corporates combined is expected to be negative, which could create additional upward pressure on existing bond prices. Investors are still underweight the asset class and we are seeing renewed interest in the sector from institutional investors globally. These positive technical factors highlighted above could provide an additional tailwind to returns.

Figure 6: Positive technical factors for emerging market debt

The left chart is a bar graph showing net issuance of sovereign and corporate bonds in emerging markets from 2018 to 2025F (forecast). Sovereign issuance remains positive throughout, while corporate issuance rises sharply from 2018 to 2021, then turns negative from 2022 onward. The graph on the right hand side shows foreign ownership of domestic debt issued by Turkey, Brazil, Mexico, South Africa, Indonesia and Thailand.