Dispelling the myths around emerging market debt
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Dispelling the myths around emerging market debt

At a glance

  • Today’s emerging markets bear little resemblance to those that were rocked by financial crises in the 1980s and 1990s, with the asset class diversified across geography, investment grade, high yield, sovereigns and corporates
  • With the JP Morgan EMBI Global Diversified Index yielding 8%, and central banks set to ease policy rates, we believe there are good opportunities
  • Columbia Threadneedle Investments has a dedicated team of 22 emerging market investment professionals seeking to unearth the best investment ideas via an active management research-driven approach

Things in emerging markets are not always what they seem. In December 2023, Argentina elected as president Javier Milei, a rabble-rousing populist fond of brandishing a chainsaw on the campaign trail. Milei had a radical agenda, including dollarising the economy and abolishing the central bank – just the kind of policies that alarm investors.

In the event, his actions have been surprisingly market friendly. Since coming to power he has devalued the Argentinean peso and cut transport and energy subsidies. He has even earned the praise of the International Monetary Fund (IMF).

Milei may yet prove to be the market’s bogeyman. But reckless policymaking in the main emerging market economies is now the exception rather than the rule. The perception that emerging markets have not moved on much since the 1980s and 1990s, when financial crises rocked Latin American and Asian countries leaving some unable to service their debts, is an outmoded one. In the past 30 years many emerging market (EM) governments have adopted institutional frameworks that guarantee prudent macroeconomic policy and contain imbalances. Sovereign defaults do occur, but in a small minority of a large and diverse investment universe.

Indeed, at a time when emerging markets fixed income is an attractive asset class with attractive yields, outdated perceptions are in danger of holding investors back. We think three myths in particular need dispelling.

The three myths

Myth 1: Emerging markets are generally economic “basket cases”

Most major EM economies now boast stable rates of growth underpinned by orthodox policy frameworks. Many have embraced central bank independence, inflation-targeting monetary policy and fiscal rules.

Of the rest, several have shown that even persistent offenders can sometimes seek redemption. Take Turkey, which has endured years of very high inflation. President Erdogan opposed raising policy rates to tackle price pressure, claiming that higher rates were themselves inflationary. Yet in the past year Turkey’s central bank has raised rates nine times, by a total of more than 400 basis points. Interest rates are now 50% and inflation is at 75%1. Everything is relative, but Turkish policy appears to be moving in the right direction.

As Argentina and Turkey show, there is no single EM “story”. The EM hard currency fixed income universe comprises more than 70 countries, all with their own idiosyncratic circumstances. We believe there is the opportunity, via active management, to build a diversified portfolio while minimising potential tail risk events.

Myth 2: Emerging market bonds are mainly junk

Nothing could be further from the truth. The hard currency EM index carries an investment grade average rating of BBB-, thanks in part to the inclusion in 2019 of Middle Eastern states such as Qatar, Saudi Arabia and the UAE2. In fact, nearly 60% of the JP Morgan EMBI Global Diversified Index is rated as investment grade3. The wealth of active management opportunities in the asset class reflects the broad range of credit qualities.

Myth3: There is significant contagion risk

Correlated imbalances were once a hallmark of emerging markets. But two decades of structural reform and policy improvement has greatly diminished the danger of a crisis in one country spilling over. The diversified exposures and idiosyncratic nature of the asset class provides much greater insulation against exogenous shocks. Consider China’s recent economic slowdown, the war in Ukraine and the crisis in the Middle East. All events that might once have spelled a systemic crisis for EM debt have in fact demonstrated its resilience and diversity and provided opportunities for active investors.

A diversified asset class

When it comes to constructing investment portfolios, the number of countries pursuing distinct economic policies fosters a diversification that mitigates many remaining tail risks. What is more, investing across EM fixed income’s three sub-asset classes can deliver further diversification. Firstly, there is the hard currency sovereign debt universe. More than 70 countries issue their debt in dollars or euros. Secondly, there is the fast-growing corporate debt sector. And, thirdly, there are the 18 countries that issue debt in their own currencies. Only those with the most credible economic policies can do so: consequently, the number of borrowers is smaller and the credit rating higher at BBB+ (Figure 1).

Figure 1: an attractive income proposition across a diversified asset class
attractive income
  • Following the most widely used definition, EMD currently consists of 70 countries and 929 bonds, a significant increase from the 14
    countries and 51 bonds available in 1993
  • Investing in EM debt gives access to government and company debt, in both investment grade and high yield, around the world
  • EMD is an underinvested asset class

Source: JP Morgan, as at 31 March 2024

The resulting asset class is diversified across geography, investment grade, high yield, sovereigns and corporates. At Columbia Threadneedle Investments, we have 22 investment professionals in the emerging markets fixed income team, located across three continents, dedicated to unearthing investment ideas including the best relative value opportunities. With just under $4 billion under management we are big enough to access all the major market counterparties, yet small enough to be nimble at times of market stress4.

An opportune time

We are encouraged by current opportunities in emerging markets fixed income. The JP Morgan EMBI Global Diversified Index is yielding about 8% – an attractive rate – although a tight yield spread over US Treasury bonds indicates the asset class is fairly valued (Figure 2).

Figure 2: spreads tighter but yield still attractive
Index valuation vs 10-year average
spreads tighter
EMBIG diversified spread and yield
diversified spread

Source: Macrobond and Columbia Threadneedle Investments, as at 30 April 2024. Past performance is not a guarantee of future returns.

At the same time, the headwinds faced in recent years from high interest rates are dissipating. Easier US monetary policy should loosen funding conditions for issuers and support emerging markets fixed income. In the meantime, Latin American central banks such as Brazil have already begun cutting (Figure 3), taking advantage of disinflation. This should stimulate economic growth in emerging markets, which the IMF has forecast will be 4.2% in 2024 against 1.7% for developed markets5.

Figure 3: rate cutting cycles have commenced in emerging markets
Average EM policy rate (14 major local markets)
em policy rates
Latin America interest rates
latin america interest rates

Source: Macrobond and Columbia Threadneedle Investments, as at 30 April 2024

Meanwhile, the IMF is helping reduce the risk of debt distress among EM issuers by making loans conditional on the implementation of reforms aimed at strengthening economic resilience. For instance, it agreed to increase its loan facility to Egypt from $3 billion to $8 billion, but insists it raise interest rates and float its pound to prevent imbalances.

There is a new reality in emerging markets, far from the myths of yesterday. We believe improving policy making is strengthening the investment case for an asset class where yields are highly attractive and falling policy rates should provide a fair wind.

9 July 2024
Laura Reardon
Laura Reardon
Client Portfolio Manager, Emerging Market Debt
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Dispelling the myths around emerging market debt

1From October 2022 to June 2024, as per Bloomberg data.
2Marmore Mena, GCC’s inclusion in J.P. Morgan’s EM Bond Index: The “Hurray” Moment, 15 October 2018
3JP Morgan EMBI Global Diversified Index, as at May 2024
4All figures as at March 2024
5World Economic Outlook, April 2024: Steady but Slow.

Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial
advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial
advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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