- ‘Spread’ is the excess compensation investors demand for taking on the increased risk of one debt issuer over another. It is currently at 3% over Emerging Market Government Bonds.
- With interest rates as high as 15% in Emerging Market countries like Brazil, yields are much more attractive than developed markets, but risk needs to be diversified.
- The default rate for EM High Yield Corporates is expected to be 3.7% in 2025, down from 3.9% in 2024, 8.7% in 2023 and 14.0% in 2022.
The complexity of Emerging Market Debt can be intimidating at first glance, not helped by the sheer amount of jargon used within the asset class, but understanding some of the fundamentals goes a long way in demystifying the wild child of fixed income and unlocking a unique opportunity.
What is it?
Emerging Market Debt (EMD) refers to buying bonds in developing markets (e.g. India, China, South Africa, Latin America). Broadly speaking, EM Debt can be split up into three categories: Hard Currency Sovereign, Soft Currency Sovereign and Hard Currency Corporate. But what does that mean?
Hard currency typically refers to US Dollars, and is coined ‘hard’ because it is stable or unlikely to move around much. Soft currency is the local currency, e.g. Brazilian real or Indian rupee and is more likely to fluctuate in value. Sovereign refers to government debt, whilst corporate is businesses / companies.
The key risk with soft currency sovereign (governments issuing debt in their own local currency) is that if they ever have problems paying the interest or the debt back, they can just print more of the currency. This devalues the currency so your investment may be worth the same amount in the local currency, but significantly less after you convert it back to GBP. Understanding local governments, and local monetary policy is key to navigating risk.
Chasing yield
As you can imagine, EM Debt comes with more attractive yields than traditional Investment Grade fixed income as EM companies and governments must compensate investors for taking the extra risk. We call this the spread, i.e. the difference between what an emerging market sovereign/corporate must pay on its debt vs what a developed market one might have to pay. This difference is further compounded with higher interest rates in emerging markets. Whilst the UK and US have central bank policy rates around 4%, Brazil is at 15%, Mexico is at 7.5%, and South Africa is at 7%.
With the return in this asset class linked so heavily to the yield, the name of the game becomes risk management, knowing how much to chase yield and where to draw the line. Whilst the 1-year UK Government bond yield is nearly 4%, the 1-year Argentinian Government bond yield is c. 40%. Does that make it a better investment? Well, with Argentina on the brink of default (for the 10th time) and likely to have to print Pesos to meet their interest requirements thereby devaluing the local currency bond, probably not.
The chart below shows that the yield in Emerging Markets, in hard currency terms, is currently above the long-term average (as you would expect from elevated interest rates). It also shows that spreads are tight, i.e., the compensation over developed market debt is below average. However, a spread of 3% isn’t bad and reflects the confidence in Emerging Markets (or the lack of confidence in US Government debt).
Source: JPM EMBI Global Diversified Blended Spread Index, 31 August 2025.
Why now?
- Inflation in Emerging Markets is trending downward which has started to lead to interest rate cutting cycles – interest rates falling means bond prices go up.
- USD weakness is supportive of EM currencies and is therefore helpful for soft currency sovereign debt.
- Fundamentals are improving in emerging market countries and their strong economic growth rates should reduce credit risk (chance to default) for both companies and governments. Corporates in Emerging Markets also aren’t as leveraged as their Developed Market counterparts, which should also help keep default rates down (forecast to be 3.7% in 2025).
Source: JP Morgan, December 2024.
- EM Debt also has lower correlation to traditional fixed income so provides good diversification from US or UK Government bonds at a time of heightened political uncertainty, increasingly unsustainable indebtedness, and rising inflation.
Bowmore portfolios
In summary, we see a lot of the core risks with Emerging Market Debt – currency, geopolitical, trade policy (tariffs), defaults, interest-rate – starting to abate. That’s not to say they’re gone completely, if they were then yields wouldn’t be as attractive as they are, but we feel confident that the risk / reward ratio is now in investors’ favour. Our income models have already dipped their toe into EMD, but it is now more than likely that we will bring the asset class into core models. We don’t need to be greedy and chase yield, but think a good balance of hard and soft currencies, corporates and sovereigns, investment grade and high yield, and regions can give clients a high single digit return with lower volatility than equity.
Source: AlphaTerminal, data as at 02/10/2025
The value of your investments can go down as well as up, so you could get back less than you invested. Past performance is not a guide to future performance.