Emerging Market Bonds: The Case For and Against

Emerging market bonds offer yields that are substantially above those available in developed markets — in 2024-2026, this yield premium is among the most attractive in over a decade. A diversified hard currency EM sovereign bond fund might yield 6-8%, compared to 4-5% for US Treasuries and 4-4.5% for UK gilts. That premium is real and accessible. So is the risk that underlies it: sovereign defaults do happen, currencies can depreciate sharply against sterling, and political changes can rapidly alter the creditworthiness of an issuer. This guide provides the framework to assess whether EM bonds deserve a place in an internationally mobile HNW investor's portfolio.

Two Fundamentally Different Products

When people discuss "emerging market bonds," they are often conflating two quite different instruments with distinct risk profiles:

Hard currency EM sovereign bonds are issued by emerging market governments (and some EM corporations) denominated in USD or EUR. The JP Morgan Emerging Markets Bond Index (EMBI) is the primary benchmark for this category. The investor bears the credit risk of the EM sovereign — the risk that the government fails to pay its coupon or principal — but not the currency risk. Brazil issues a dollar-denominated bond; if the Brazilian Real weakens against the USD, the bondholder's principal (in dollars) is unaffected. This is a meaningful simplification: one risk instead of two.

Local currency EM bonds are issued in the EM country's own currency — Brazilian Real bonds, South African Rand bonds, Turkish Lira bonds, Indonesian Rupiah bonds. The investor bears both the credit risk and the currency risk. The currency risk is the more significant dimension for most investors: the Turkish Lira has depreciated by over 80% against the USD in the past five years, meaning any yield advantage (Turkish lira bond yields were above 30% in 2023) was obliterated multiple times over for a non-Lira investor. The JP Morgan GBI-EM Index is the primary benchmark for local currency EM bonds.

The appropriate default approach for most internationally mobile HNW investors is hard currency EM bonds — which provide the yield premium without the currency overlay risk that is difficult to manage without specialist expertise.

Why EM Bonds Are Attractive in the Current Environment

The yield environment for EM bonds in 2024-2026 is the most attractive since before the 2008-2009 financial crisis, for several reasons:

Higher developed market rates. US interest rates rose from near zero to approximately 4.25-4.5% by 2025. This created the backdrop for EM yields to rise correspondingly, as EM bonds must offer a sufficient premium over US Treasuries to attract investors.

Many EM central banks moved early. Brazil, Mexico, South Africa, Indonesia, and others raised rates aggressively in 2021-2022 to control inflation — in many cases before the Federal Reserve began its hiking cycle. This pre-emptive action helped control inflation, brought local currency yields to very attractive levels, and in some cases has allowed these countries to begin cutting rates while developed market rates remain elevated.

Real yields in some EM countries are very high. Brazil's benchmark rate reached 13.75% in 2023 with inflation at approximately 4-5%, implying a real yield of approximately 8-9%. These real yields are extraordinary by global standards. Even in hard currency dollar terms, the spread above US Treasuries for investment-grade EM sovereign bonds has been in the 2-3% range — historically attractive.

The Risk Landscape

Sovereign credit risk. EM governments can and do default. The 2022-2024 period saw a cluster of EM defaults: Sri Lanka (tourism and remittance collapse combined with debt accumulation), Zambia (commodity dependence and COVID spending), Ghana (fiscal deterioration and external debt burden), and ongoing Argentina restructuring discussions. The common factors are high external debt relative to export revenues, political fragility, dollar strengthening (which makes dollar-denominated debt more burdensome), and commodity price shocks. A diversified EM bond fund spreads this risk across 50-70 issuers, so a single default has limited portfolio impact.

The "Fragile Five" framework. Analysts have identified characteristics that make EM sovereigns vulnerable: large current account deficits (requiring constant foreign capital inflows), high external debt relative to GDP, low foreign exchange reserves, political instability, and fiscal deficits. Countries that combine several of these factors are at elevated default risk, particularly during periods of dollar strength or global risk aversion.

Currency risk (for local currency bonds). The depreciation of EM currencies against major currencies has historically been a consistent headwind for non-EM investors in local currency bonds. Many EM currencies have underlying structural pressures — inflation differentials, current account deficits, political instability — that create gradual depreciation over time. The Brazilian Real, Turkish Lira, South African Rand, and Argentine Peso have all depreciated significantly against GBP and USD over the past decade. This does not make local currency EM bonds uninvestable, but it means the yield premium must be assessed against the currency depreciation history.

Political risk. Elections in EM countries can produce dramatic fiscal policy changes. Brazil has seen significant swings in fiscal policy between different administrations. Argentina's fiscal trajectory depends heavily on the political cycle. Turkey's monetary policy has been unusual by global standards, creating extraordinary currency volatility. Political risk is inherent in EM credit.

Geopolitical risk. EM countries in geopolitically sensitive regions — Eastern Europe (Ukraine, Moldova), the Middle East, parts of Africa — face elevated risk that can affect their creditworthiness.

The Carry Trade Dimension

The carry trade — borrowing in low-interest-rate currencies (historically the Japanese yen or Swiss franc) and investing in high-yield assets — has been an important driver of EM bond returns for decades. When the carry trade is working, EM bond yields compress and prices rise. When it reverses — as in August 2024 when unexpected yen strengthening caused rapid carry trade unwinding globally — EM bond prices can fall abruptly regardless of the fundamental credit quality of the issuer.

Understanding that EM bond returns are partly driven by global capital flows and carry dynamics, not just the underlying sovereign credit, is important for expectation-setting.

Practical EM Bond Fund Options

For internationally mobile investors accessing EM bonds through liquid UCITS vehicles:

iShares JP Morgan USD Emerging Markets Bond UCITS ETF (SEMB) — passive exposure to hard currency EM sovereign bonds, tracking the JP Morgan EMBI Global Core Index. Diversified across approximately 50+ issuers. The largest exposure is typically Brazil, Mexico, Indonesia, South Africa, and Turkey. Low cost, high liquidity.

PIMCO Emerging Markets Bond Fund — active management from one of the world's largest fixed income managers. Active management in EM bonds has historically added value through credit selection and duration management.

JPMorgan EM Bond Fund (EMBI benchmark) — another active approach from an institution with very deep EM research capabilities.

iShares JP Morgan EM Local Government Bond UCITS ETF (SEML) — for investors who want local currency exposure (accepting the currency risk in exchange for the higher nominal yield).

M&G Emerging Markets Bond Fund — a well-regarded active EM bond fund with a long track record.

Building EM Bond Exposure into a Portfolio

For a balanced HNW portfolio, the typical role of EM bonds is as a yield-enhancing component within the fixed income allocation. A reasonable range is 5-10% of total portfolio (or 15-25% of the fixed income sleeve, if fixed income is 30-40% of the total portfolio).

The preference should generally be hard currency for investors without specialist currency management capability. The yield premium of hard currency EM bonds over developed market investment-grade bonds (the "spread") has historically compensated for default risk over full cycles — though individual years may see significant underperformance during risk-off episodes.

Local currency EM bonds can be added in small quantities (2-3% of portfolio) for investors who want exposure to EM currency appreciation potential alongside the yield. This is more speculative and should be sized accordingly.

The EM bond allocation should be assessed alongside EM equity exposure in the total portfolio — investors who already hold 10-15% of their equity in emerging markets are already taking significant EM country and currency risk, and may not need additional EM bond exposure.

How Global Investments Can Help

Internationally mobile investors often have genuine insights into specific EM countries — they may live in or travel frequently to the regions where EM bond issuers are located. Our fixed income advisory team helps clients build EM bond exposure that reflects both the portfolio-level yield enhancement objective and the specific country and currency risks they are most comfortable accepting. We advise on hard currency versus local currency allocation, active versus passive management, and appropriate fund selection given clients' tax residency and wrapper preferences. Emerging market investments can be highly volatile; sovereign defaults can result in significant loss of capital; currency movements can eliminate yield advantages; seek professional financial advice before investing in emerging market bonds.