The Quiet Outperformer: Why EM Bonds Deserve a Second Look

The fundamental case for investing in emerging markets (EM) bonds has been building for some time, but investors have shown little interest in the asset class over the past several years. However, this might be changing. Ongoing tariff drama has served as a catalyst, but the long-term drivers of this shift are not new, and could be set to continue. Recent and longer-term returns reflect this. Emerging markets bonds have strongly outperformed U.S. and global aggregate bonds this year, as well as investment grade and high yield U.S. credit. Longer term, emerging markets bonds have been quietly outperforming the U.S. and global broad markets over the past decade, and in particular since 2022. Investors should remember that past performance is no guarantee of future results.

EM Bonds Have Outperformed Global and U.S. Markets Over the Last Decade

Source: Morningstar as of 31/05/2025. EM Bonds is represented by the 50% J.P. Morgan EMBI Global Diversified Index/50% J.P. Morgan GBI-EM Global Diversified Index; Global Broad Market is represented by the ICE BofA Global Broad Market Index; U.S. Broad Market is represented by the ICE BofA US Broad Market Index. Performance figures are shown in U.S. dollars (USD). Returns may increase or decrease as a result of currency fluctuations. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest directly in an index.

Key Risks

• Currency fluctuations can materially affect returns on emerging-market (EM) bonds, particularly when bonds are issued in local currencies.
• Sovereign and corporate issuers in EM countries face higher default and restructuring risk than developed-market issuers.
• Political instability, capital-control measures and lower market liquidity can increase price volatility and may delay or prevent exit.
• High-yield EM bonds carry elevated credit and downgrade risk; investors could lose some or all of their capital.

Performance Is Speaking Loudly

A key driver in this outperformance is the higher yield. As of May 31, 2025 EM bonds yielded 7.5%, a 2.8% increase over the broad U.S. bond market and more than 3% above the 10-year U.S. Treasury bond yield. In addition to these high nominal yields, real yields in emerging markets have been significantly higher than those in developed markets, favoring the case for local currency bonds in particular. Central banks have demonstrated a strong focus on keeping inflation under control, by hiking rates far before most developed markets and keeping real rates high. High real rates support emerging markets foreign exchange (EMFX) rates, providing central banks flexibility to ease rates if needed to support economic growth. Further, fundamental metrics, such as debt-to-GDP ratios, fiscal deficits, and current account balances compare favorably to developed markets.

Developed Markets: Growing Risk, Diminishing Reward

In addition to the long-term fundamental strength we see in emerging markets, we also see increasing risk in developed markets. Ongoing political dysfunction and the inability to address increasing debt levels means that investors may not be adequately compensated for the risk they are taking. These dynamics, as well as continued inflationary pressures, put pressure on developed markets rates, which could drive underperformance. The dollar’s ongoing role globally has started to be questioned, and recent behavior of U.S. rates and the U.S. dollar has not followed historical patterns. Heightened geopolitical risk may keep commodity prices high, stoking inflation and pushing yields higher in the U.S. while putting further pressure on the U.S. dollar – while benefiting emerging markets.

Why Now? Diversification and Dollar Dynamics

Altogether, we think there might be a good case for diversifying a U.S.-centric fixed income portfolio towards emerging markets bonds, given low to moderate correlation with other fixed income asset classes and strong negative correlation to the U.S. dollar (particularly local currency denominated bonds). With many investors being underinvested in EM bonds, it could be the time to consider higher exposure to the asset class. With risks growing in developed markets, stronger fundamentals in EM and more attractive EM bond yields, it is possible that the outperformance we observe continues. However, there is no guarantee that such returns will be achieved and investors may lose part or all of their investment.