Despite being the world’s largest pool of credit, at US$29 trillion1 in size, emerging market debt (EMD) remains one of the most misunderstood markets amongst investors. We provide an overview of EMD and help investors consider the practical aspects of investing in this asset class.
What is emerging market debt
Emerging market debt refers to the outstanding tradeable debt issued by emerging market governments or corporations domiciled in those countries. Of the roughly 200 countries in the world today, 41 are considered ‘developed’ economies by the International Monetary Fund (IMF) with the remaining classified as ‘emerging market and developing’. Combined, emerging market economies account for over 50% of global Gross Domestic Product (GDP), 45% of global consumer spending and roughly 87% of the world’s population2. The EM debt universe comprises four primary sub-classes: hard currency (denominated in a globally traded currency of a developed country, such as the US dollar or euro) and local currency and containing both sovereign and corporate debt.
Why invest in emerging market debt
There are several key benefits that investors find attractive within EMD, including diversification, yield premium and an opportunity for compelling returns. Emerging markets provide investors with access to a wider array of idiosyncratic returns drivers which can be uncorrelated to other asset classes. EMD may also provide investors with a yield advantage, compensating them for venturing out of their core markets and providing an effective cushion against market volatility. In addition, we highlight the benefit of active management with emerging market debt, which provides a fertile hunting ground for sourcing alpha opportunities.
Ways to access emerging market debt
We introduce a framework to help investors consider the most suitable way to access EMD including benchmark relative and several benchmark agnostic strategies, including unconstrained, absolute return (long/short) and private credit.
Dispelling myths concerning emerging market debt
There are several misconceptions that exist in some investors' minds, and we help put those in context. While some may view EMD as a niche asset class, we explain that in total, it’s a very substantial pool of assets.
Some also believe that because EMD offers a yield advantage, this must signify lower credit ratings, the reality is that EMD has an investment grade rating, on average.
Finally, while EMD is sometimes viewed as inherently risky, we discuss how the asset class demonstrates stronger underlying fundamentals than developed markets.
Conclusion
EMD can offer solutions to investors looking for yield, diversification, and the opportunity for excess returns. In our judgement, it deserves to be a core holding in investors’ overall fixed income allocations. However, investing successfully in EMD requires a level of specialist expertise to mitigate the challenges.
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