Emerging market local debt: Expanding fixed income investment opportunities

Outside of Canada, developed market (DM) large-cap equity valuations and expected returns remain relatively unattractive. DM government bond yields have risen to more attractive levels but are still low by historical standards. Inflation remains relatively high and sticky, and recession risks are elevated. These are important headwinds to the performance of a traditional balanced portfolio focused on public equity and core fixed income.

Expected portfolio performance can be improved by increasing investment breadth. This requires investors to identify additional distinct and diversifying sources of return. Potential options include new asset classes not currently encompassed by an investor’s portfolio, unique opportunities within existing asset classes, and increased geographic diversification; for more details, read Long-term strategic allocation. EM debt is an increasingly accessible opportunity that allows investors to exploit all three of these additional investment options.

Relatively few investors currently invest in EM debt. Those investors who already do can expect to be rewarded for extending out along the fixed income yield curve and accepting exposure to the additional risks inherent in EM debt. These risks include idiosyncratic economic, political, and liquidity risks associated with individual EM countries. And with countries across the globe often at different stages of the economic cycle, geographic diversification accessible through an allocation to EM debt helps add another layer of expected return to portfolio performance.

The number of individual country EM bond markets has doubled since 2009 and now totals 50.1 Concurrently, the amount of EM debt outstanding has risen strongly, reaching $26.5 trillion in April 2023.2 This includes local currency and hard currency debt — typically in U.S. dollars (USD) — issued by sovereign governments and locally domiciled corporates.

The EM debt market is already much bigger than the global high-yield market. And yet, further substantial growth is likely as outstanding EM debt has failed to keep pace with the growth of EM countries’ share of World GDP. EM local sovereign debt constitutes only 15% of the global government bond market, whereas emerging markets represent 43% of World GDP. Deepening liquidity will provide investors with an increasing opportunity to participate in this asset class.

Nowadays, most EM debt is issued in the local currency of the issuing government or corporation. This was not always the case. In the early days of the asset class, few EM central banks enjoyed a reputation for monetary policy credibility. This led investors to demand debt denominated in USD, and occasionally euros, to minimize the risk of inflation that would undermine the value of their assets.

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If you’d like to discuss emerging market debt investment opportunities or have questions about your investment portfolio, please reach out to your advisor or CIBC representative any time.

¹ J.P. Morgan (2022), EM Local Markets Guide. 13th Edition. September.

² Bank for International Settlements (BIS), Summary of Debt Outstanding, April 2023.