The Case for Allocating to Emerging Market Debt

Emerging market debt (EMD) is a versatile asset. It offers equity investors risk mitigation potential with modest return dilution. For fixed income investors willing to move out the risk spectrum, EMD presents a significant yield pick-up opportunity. The COVID-19 pandemic led to a notable rise in indebtedness in some countries and, now more than ever, investors need to be comfortable with headline and idiosyncratic risk, look beyond average index level metrics and be mindful of individual issuer risks. However, the broad move higher in yields may present a much more rewarding entry point for those investors prepared to take a closer look.

Key points for investors to keep in mind include:

• Yield Enhancement Emerging market debt provides an attractive yield pick-up relative to developed market bonds.
  
• Diversification Benefits The low correlation and higher growth factor exposures of EMD assets provide diversification benefits for global bond and equity investors.
• Evolving Fundamentals While emerging economies offer relatively strong growth, economic scarring from the pandemic will likely extend the time required to recoup lost output.
• Higher Volatility/Drawdown and Idiosyncratic Risks Investors need to be aware of the potential higher volatility and drawdowns as well as the idiosyncratic risks associated with EM assets (Russia’s removal from benchmarks serves as a striking reminder).