Investment-grade bonds from emerging markets currently represent a compelling alternative to US corporate bonds. Although market volatility has decreased somewhat since the ‘Liberation Day’ sell-off in April, overall uncertainty remains high. This is due to factors such as US trade tariffs, geopolitical tensions, concerns about the rising US national debt, and discussions surrounding the Federal Reserve’s independence. At the same time, US equities have rallied strongly while earnings growth has weakened, leading many investors to seek more stable sources of income and better risk diversification, according to Dr. Frank Härtel, Head of Asset Allocation at Bank J. Safra Sarasin.
Over the past ten years, the debt market in emerging countries has grown significantly. Many countries in Asia, Latin America, the Middle East, and Eastern Europe have improved their economic policies, strengthened their public finances, and reduced their vulnerability to external shocks. This has led to a substantially higher proportion of investment-grade bonds. Furthermore, since the ‘taper tantrum’ in 2013, companies in these countries have significantly reduced their debt loads after becoming aware of their sensitivity to US interest rate developments. As a result, their balance sheets are often more robust than those of comparable US companies today.
A better risk-return profile
This solid foundation is also reflected in their performance. In recent years, corporate bonds from emerging markets have demonstrated a better risk-return profile than US corporate bonds. They experienced similar price declines during crises but recovered faster, for example after the COVID-19 pandemic and the war in Ukraine. The spreads on EM bonds have now narrowed significantly and are close to those of US bonds, while their underlying quality is often stronger. Interestingly, some emerging market countries are even able to borrow more cheaply than the United States, indicating how much stronger their credit standing has become.
An additional factor supporting the market is that very few new bonds have been issued by emerging market companies in recent years. This means relatively little new supply is coming to market, while demand is beginning to recover. Furthermore, many so-called ‘momentum investors’ have left this market, which has reduced volatility and created opportunities for investors with a longer-term horizon.
A careful approach required
Nevertheless, investing in this market requires a careful approach. While passive ETFs offer convenience, they capture a limited part of the total investable universe. Moreover, the differences between countries, sectors, and individual companies are significant, allowing active fund managers to add value through careful selection. When choosing a fund, one must be cautious with standard fund comparisons, as many categories contain a mix of investment-grade, high-yield, and even local currency strategies, meaning their respective risks can vary widely.
In summary, investment-grade corporate bonds from emerging markets offer an attractive combination of stronger fundamentals, spreads comparable to US corporate bonds, and a historically better risk-return profile. For investors who invest in US dollars and wish to be less dependent solely on US economic developments, this category represents an interesting and often underestimated alternative.
