We are celebrating two decades since the birth of local currency debt in emerging markets (EM) in June of 2025¹. For an asset class that has now become one of the biggest debt markets globally, two decades feels like a brief moment². 

During that time, we have made enormous progress, with almost all of the core markets that make up the local debt benchmarks now exhibiting strong fundamentals. This can be seen through highly credible inflation targeting central banks, with low and manageable current account deficits, low external debt profiles, large local asset bases (in some cases over 100% of GDP), and ample reserves.  

How we got here has been a gradual story of trial and error that has taught these EM markets valuable lessons about how to adapt credible central bank policies that work for them domestically. 

Yet, many investors still view EM local currency debt as a high yield, highly volatile, beta asset class. We have a different view and believe EM local currency debt as a core, high grade asset class with significant alpha opportunities. 

1. Perception: EM local is just a risk on asset class

Reality: Local is EM’s core markets

To be a core allocation in investors’ portfolios, an asset class should have three key characteristics. Size, quality and fundamental strength.

The sheer scale of EM local currency debt may surprise some investors. The market standard JPMorgan Government Bond Index – Emerging Markets (GBI-EM) benchmark currently has US$ 5 trillion in total tradeable debt². This is over three times the size of the more commonly spoken about EM hard currency government debt represented by the JPMorgan Emerging Market Bond Index (EMBI). When including “off benchmark” securities, we estimate the size of the market to be around US$ 20 trillion in size and 47 issuers, with the asset class growing by 700% over the past 20 years¹.

The composition of the EM local investment universe has been changing over time. In 2005, EM local markets were leaning towards EMEA based markets such as Czech Republic, Hungary and Slovakia. Through the 2000s the asset class saw an increase in Latin American markets like Brazil, Peru and Colombia. More recently the universe has evolved again with large Asian markets more prevalent with Malaysia, India and Indonesia now more substantial weights in the index¹. 

Next, we turn to quality, where the most commonly used index of the GBI-EM Global Diversified has an “investment grade” average rating of BBB. For such a large market it is remarkable that constituents all remain of such high quality, with zero issuers rated below BB, while still presenting such an attractive yield¹. Again, this contrasts with EMBI, which relies on a larger number of lower rated securities, including some distressed securities, to increase yield¹. 

This is logical, as only larger EM markets, which have established domestic capital markets, are able to issue debt in their own local currency. This contrasts with EMBI which contains some smaller markets unable to issue debt in their own local currency so needed to utilise US capital markets in order to borrow. Issuing debt in their domestic currency is a goal for many EM markets. As such, by issuing bonds in their local currency, EM governments can more closely match their spending and borrowing needs without having to worry about exchange rate risks when repaying. 

Finally, the fundamentals of emerging market markets also provide a strong foundation for the asset class. Emerging markets have repaired their trade balances post-Covid and now have low current account deficits. In addition, the fiscal balances in many EM markets are lower than pre-Covid levels, unlike most developed market markets¹.

One lingering deterrent for some investors is the credibility of EM central banks, due to the perception that they don’t target inflation well. On an idiosyncratic level, there may be some historical support for this assumption, as through time there have been numerous cases of specific markets losing control of inflation grabbing news headlines. Yet, this may not be a fair representation of broad EM central banks in the core part of the EM local investment universe. An increasing proportion of EM central banks have been implementing inflation targeting regimes along with and becoming more transparent, improving their credibility on the world stage¹.

2. Perception: FX takes away all your return

Reality: FX involves active hedging management as a key component

A common misconception that we hear from investors is that the foreign exchange (FX) component of the underlying security provides too much volatility to an EM local allocation. While it is true that unhedged FX has historically added volatility to portfolios, this is not unique to EM, but rather is true when adding any foreign currency to a portfolio. Therefore, the question for investors is do you want to be 100% in your base currency denominated assets or do you want to add diversification. The volatility difference between G10 FX and EM FX has been near zero for multiple years¹.  

For investors seeking to manage or reduce the FX risk in their portfolios, a fully hedged approach can be utilised. This is the standard approach in developed market fixed income portfolios but is yet to become common in emerging markets. The argument against this is that hedging the FX could mean giving up the higher yield that makes EM local attractive. However, with steeper yield curves in EM than DM, investors have the opportunity to reduce their risk significantly by hedging FX while still having attractive yields from the underlying bonds¹.  

Along similar lines, the base currency of the portfolio is also an important consideration for deciding whether to hedge or not. It can be harder for a USD based investor to consider non-USD assets right now, however if your portfolio is denominated in another currency such as euros, your experience has been very different. For example, since 2021, EM local is down 10% for USD based investors given the wider sell off in fixed income markets in 2022 and a stronger US dollar. Yet, for AUD based investors, unhedged EM local is up 10%, with similar returns for JPY based investors. EUR based investors would have experienced a 7% gain¹.

Finally, there is an added bonus when it comes to the optionality that EM local provides. Any turn in the USD trend can be punitive for such trades. This effect will be more profound in EM since EM local investors significantly increased their share of offshore US dollar assets and any unwind in this trend will have significant consequences for FX markets.

3. Perception: EM local relies on heavy foreign participation

Reality: EM (core) local is becoming increasingly dominated by local players

The story of the investor base represents the changing nature of emerging markets themselves. EM local is still a relatively new asset class within global fixed income and in the last two decades, emerging markets have transformed. Economies have grown, central banks started inflation targeting, credibility in nascent monetary policy frameworks grew, markets have become wealthier and savings more robust.

That has given birth to an increasing number of pension funds, life insurance companies and local banks, leaving big monopolies behind and creating vibrant interbank markets. This asset class is now predominantly dominated by domestic investors which makes sense from a local perspective. Their obligations, whether through pension liabilities, insurance contracts or deposits, are in their local denominated currency¹. 

The rise of domestic investors buying their own government debt also de-sensitises EM bonds to FX fluctuations. The rising local participation has led to a reduction in FX and rates correlation in the market, given a large share of investors are now FX agnostic. The impact of this for global investors is that there is now a growing foundation of support for EM local currency bonds. Domestic investors tend to be long-term investors and, as such, if global uncertainties arise it can be reasonably expected that local investors won’t be selling their own government bonds in times of hardship.

4. Perception: It’s all beta to the global macro environment 

Reality: Increasing sources of local alpha as benchmark expands, and locals view a different universe to foreigners 

As local investors became significantly larger players in EM local debt market, and governments became more nuanced in debt management, we have seen a birth of a relative value alpha opportunity for EM local managers. Unlike EM USD denominated debt, EM local yield curves and instruments are a lot more varied, providing these relative value opportunities. Examples of these opportunities range from the basic, such as each market in the index presenting a broadening yield curve with 10-year to 30-year bonds. Additionally, a robust inflation-linked bond market is emerging, providing another valuable tool for active management. Liquid derivative markets are also accessible, facilitating hedging and tactical positioning. Collectively, these factors are rapidly enhancing the potential for achieving relative value alpha with minimal beta impact on a portfolio.

Frontier EM local debt, a newer development in EM local, has actually been one of the high conviction asset classes in the last few years, however specialist insight is needed to manage risk appropriately. Yet the sub-asset class provides significant two-way alpha opportunities. Examples of these include the Egyptian pound and Nigerian naira, which both devalued over the past couple of years following momentum to reform. An increasing number of frontier dedicated funds are providing capital to the asset class. However, we believe a dynamic risk allocation between high grade EM local core markets and high alpha frontier markets is the one of the ways to capture the opportunity in EM local debt¹. 

5. Breaking beta for a more consistent core income diversifier 

We expect EM governments to increase their local debt issuance over time. As these economies develop, the stability of these markets will be supported by domestic buyers. The increasing amount of issuance in the market will in turn lead the asset class to be more important on the global fixed income stage. However, for investors, EM local markets should not be a beta asset class. Though it has become easier to access with a multitude of different investment vehicles available to invest into the market, the ability to gain exposure to the asset class is not the same as investors actively allocating to the asset class. Investors should consider the potential drivers of returns and associated risk proficiently. EM local currency rates are often high, presenting investors an attractive potential yield on their investment. This, however, does not mean that investors should go chasing the highest yield in the search for future returns as valuations should be considered within the context of the fundamental economic backdrop of the Market and wider macro environment. In a similar fashion, the currency of the debt and its impact on risk and returns should also be properly understood. For investors looking for global diversification, EM local currency government debt will become a core part of their fixed income portfolio exposure if it has not already.