Emerging Market Credit: A Guide to Global Investing

Emerging market credit is a type of investment that involves lending to companies or governments in developing countries. It can be a high-risk, high-reward strategy for investors.

Investing in emerging market credit can provide access to a larger pool of potential borrowers, increasing the chances of finding a good investment opportunity. The global emerging market debt market is expected to reach $2.5 trillion by 2025.

Investors should carefully consider the risks associated with emerging market credit, including currency risk and credit risk. The average credit rating for emerging market debt is BB, indicating a higher level of risk compared to investment-grade debt.

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Emerging market credit has proven its resilience, navigating macroeconomic headwinds and regional challenges with proactive policy responses from EM central banks.

These central banks have enhanced their market credibility over the past decade, allowing greater independence from the Fed in setting policy. This flexibility has enabled them to respond more effectively to their domestic economic conditions.

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The early rate cuts by EM central banks have created a more favorable environment for corporate debt issuers, strengthening corporate financial positions and lowering default risks.

Investing in emerging market bonds can provide portfolio diversity, as their returns are not closely correlated to traditional asset classes.

Emerging market bonds issued in local currencies can also help investors offset currency risk present in the rest of their portfolios, making them a valuable tool in hedging this risk.

Developing countries have a tendency to grow rapidly, which can enhance returns and result in higher yield returns of emerging debt compared to U.S. Treasuries.

The JPM Corporate EMBI Broad Diversified index has grown to nearly USD 500 billion, but the broader investment universe for external EM corporates exceeds USD 1.5 trillion, suggesting there's still room for growth and discovery in the market.

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Emerging market credit has proven its resilience throughout 2024, navigating both macroeconomic headwinds and regional challenges. A key factor behind this performance has been the proactive policy responses from EM central banks, which have been able to stabilize growth and control inflation.

Emerging market credit has evolved into a distinct, stand-alone asset class, with the JPM Corporate EMBI Broad Diversified index growing to nearly USD 500 billion. However, the broader investment universe for external EM corporates exceeds USD 1.5 trillion, suggesting that strict index rules leave significant portions of the market untapped.

The iShares JPMorgan USD Emerging Markets Bond ETF, launched in December 2007, tracks the JPMorgan EMBI Global Core Index, a very broad, U.S.-dollar denominated, emerging-markets debt benchmark. This ETF is best suited for investors looking for a diversified path to high-yielding fixed income.

Emerging market bonds are considered sovereign debt, typically issued in foreign currencies such as U.S. dollars, euros, or Japanese yen. The credit rating on emerging market bonds tends to be lower than that on developed market bonds, due to the increased economic and political risk present in these countries.

The Sharpe ratio of various asset classes shows that CEMBI IG has a compelling Sharpe ratio, indicating that emerging market corporate investment-grade bonds offer a higher return for a given level of risk compared to other asset classes.

Investors often track the yield of U.S. Treasuries versus emerging market bonds and look for a widening of the spread, or extra yield, that emerging market bonds can offer at any given time. The higher the basis point spread of this yield is, the more attractive emerging market bonds are relative to Treasuries as an investment vehicle.

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Emerging market debt risk is assessed by rating agencies such as Standard & Poor's and Moody's, which measure each developing nation's ability to meet its debt obligations. Countries with a rating of 'BBB' (or 'Baa3') or higher are generally considered investment grade, while lower ratings indicate speculative-grade investments with relatively higher risk.

The JP Morgan EMBI Global Index is an extended version of the EMBI+ Index, which measures Brady bonds, dollar-denominated loans, and Eurobonds issued primarily by Latin American countries. The EMBI Global Index includes a broader range of countries, with no single country comprising more than 2% of total holdings.

Here are some key statistics on emerging market bonds:

Note: The sizes listed are approximate and based on data from 2024.

Emerging market credit has proven its resilience throughout 2024, navigating both macroeconomic headwinds and regional challenges. The proactive policy responses from EM central banks have been a key factor behind this performance, stabilizing growth and controlling inflation.

EM credit has evolved into a distinct, stand-alone asset class, with the JPM Corporate EMBI Broad Diversified index growing to nearly USD 500 billion. The broader investment universe for external EM corporates exceeds USD 1.5 trillion, suggesting that strict index rules leave significant portions of the market untapped.

Investors can find hidden value in segments of the EM credit market that lie beyond standard benchmarks, as trading volumes and market liquidity have increased due to growing institutional interest. This has created opportunities for investors to capture higher yields.

Emerging market companies are often underrated relative to their strong fundamentals, partly due to the country ceiling approach used by rating agencies. This has resulted in many high-quality emerging market companies being assigned lower ratings than their balance sheets suggest.

Emerging markets corporate bonds (CEMBI Broad Div) offer better risk-adjusted returns than developed market bonds, as demonstrated by higher Sharpe ratios and stronger cumulative returns. Despite higher volatility, emerging market credit delivers consistently strong performance.

Investors seeking both stability and growth potential can benefit from the diversification benefits of emerging market credits. Emerging markets have demonstrated resilience through stronger, proactive policies and corporate deleveraging, highlighting the disconnection between emerging market economies and developed markets.

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The outlook for emerging markets is a complex and ever-changing landscape. Latin America's outlook is stable, but debt costs and US policy changes pose significant risks.

In contrast, the outlook for Chinese regional and local governments remains negative due to their large debt burden. This is a major concern for investors.

The Asia-Pacific region, however, is expected to have a stable outlook, driven by firm growth and slowing inflation. This is a positive sign for investors looking to tap into this region's potential.

Here are the regions mentioned in the article with their corresponding outlooks:

The Latin America region has a stable outlook, despite facing some significant challenges. High interest rates and inflation are still a concern for many countries in the region.

Latin America's economies and governments vary greatly, but they're all dealing with the same issues. Climate change is also a major concern, but it's not the only one.

Panama's banks are struggling with shrinking margins, but falling interest rates are helping to boost portfolio quality. On the other hand, Argentina's banks are starting to shift from a cautious approach to a more growth-oriented strategy as the country's macroeconomic situation stabilizes.

Financial inclusion is on the rise in Latin America, which is actually helping to boost bank liquidity. However, this also means there's more competition in the market.

Here's a brief overview of some key countries in the region:

Moody's is hosting a virtual event on emerging markets in 2024, where they'll discuss credit opportunities across the globe.

This event will delve into the complex dynamics of emerging markets, including sustainability, recovery potential, and liquidity amidst higher-for-longer rates.

The event will specifically focus on Asia's emerging markets, navigating the interplay of these factors in the dynamic credit landscape.

It's worth noting that Moody's is a reputable source for credit analysis and insights, making this event a valuable resource for investors and industry professionals.

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China's credit risks are evolving due to a structural economic shift, protracted adjustment in the property sector, and changes in the regulatory and geopolitical environment.

The outlook for Chinese regional and local governments remains negative due to their large debt burden. This is a significant concern that investors should be aware of.

The US-China rate gap is boosting the issuance of convertibles and dim sum bonds by Chinese corporates, which is an interesting trend to watch.

China's new investment fund guidance aims to prioritize state capital for growth sectors, which could have a positive impact on the country's economic development.

In contrast, the outlook for Central and Eastern Europe sovereigns is stable due to strong growth, which is a positive sign for the region.

Middle East and North Africa's outlook is stable on growth and reforms, despite conflict risks, which is a testament to the region's resilience.

Sub-Saharan African sovereigns' outlook is also stable, as financing conditions improve, which is a welcome development for the region.

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China is experiencing a structural economic shift, which is leading to evolving credit risks.

This shift is being driven by a protracted adjustment in the property sector, which has significant implications for the country's economy.

The outlook for Chinese regional and local governments remains negative due to their large debt burden.

A notable trend in China is the issuance of convertibles and dim sum bonds by Chinese corporates, thanks to the US-China rate gap.

China's new investment fund guidance aims to prioritize state capital for growth sectors, which could have a positive impact on the economy.

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Latin America is a region where economies and governments vary considerably. The region is grappling with still-high interest rates and inflation.

Panama's banks are experiencing margin strains, which will persist even with falling rates that help shore up portfolio quality. Falling rates are actually a good thing for Panama's banks, as they make their portfolios more stable.

Argentina's banks are starting to shift their focus from caution to growth, thanks to advances in macroeconomic stabilization. This is a positive development for Argentina's economy.

Latin America's rising financial inclusion is having a positive impact on bank liquidity, despite new competition in the market.

The credit quality of debt issuers in Central and Eastern Europe is strong, with a stable 2025 outlook due to strong growth.

Geopolitical tensions and climate change are significant factors affecting credit quality in this region.

Central and Eastern Europe sovereigns' 2025 outlook is stable on strong growth, according to Moody's ratings.

Climate change and economic specialization also play a role in shaping credit quality in these diverse regions.

Middle East and North Africa has a stable outlook on growth and reforms despite conflict risks.

Economic specialization is a key factor in the credit quality of debt issuers in these regions.

Financing conditions are improving for Sub-Saharan African sovereigns, leading to a stable outlook.

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