In brief:
- Sovereign emerging market (EM) bond fundamentals have been resilient, despite market volatility, and all-in yields are attractive.
- Risk is rising for EM sovereign investors due to the increasing weight of lower-rated bonds in the index and the potential for a U.S. recession.
- The CCC-C segment of the Emerging Markets Bond Index Global Diversified (EMBIGD) has typically performed worse in periods of stress.
- The JPM EM Risk-Aware Bond Index uses a proprietary, quantitative process that seeks to minimize exposure to higher-risk countries.
- Investors can access this risk-aware approach through the JPMorgan USD Emerging Markets Sovereign Bond ETF (JPMB).
Sovereign emerging market (EM) bonds fundamentals have been resilient in the recent volatile market environment. EM economies still expect higher growth, despite a slowdown in developed markets, and spread and yield moves in EM markets were relatively muted during the volatility around U.S. tariff announcements.
Current tight spread levels are set against a backdrop of higher absolute levels of U.S. Treasuries. As a result, all-in yields for EM sovereigns are well above the average of the last 10 years and are attractive compared to developed market peers (Exhibit 1).
However, two key risks for EM sovereign debt markets have increased: the number of lower-rated bonds in the index and the potential of a U.S. recession. Understanding how riskier bonds have behaved in previous downturns is critical to managing portfolio risk and maintaining performance.
Risk from the riskiest EM sovereign bonds is rising
EM sovereign investors may be taking on more risk as the riskier part of the Emerging Markets Bond Index Global Diversified (EMBIGD) grows. The allocation to bonds rated CCC-C has been steadily rising since 2019 and is now 9.60% of the overall index, as of June 30, 2025. In addition, the contribution of CCC-C spreads as a percentage of the overall index spread since 2022 has meaningfully increased. As a result, 40% – 60% of the index spread is coming from the riskiest segment of the market (Exhibit 2).
Recent notable selloffs in the EM sovereign market highlight the risk of CCC-C segment. In the pandemic sell-off of 2020, most rating buckets of EMBIGD managed to recover after the initial decline but the CCC-C segment did not experience the same rebound. In 2022, the EM sovereign market broadly declined on a variety of macro and geopolitical factors and the performance of the CCC-C bonds was meaningfully weaker (Exhibit 3).
More recently the extra risk has actually paid off and the CCC-C segment has significantly boosted the total return of the EMBIGD. However, in 2025, this area of the market is facing mounting pressure from macroeconomic uncertainty. While select countries are benefiting from positive credit developments, the broader distress rally appears to be waning. Spreads for CCC-C bonds have declined to well below the decade-long average and could widen in the case of a U.S. recession (Exhibit 4). The large weight of these bonds in the EMBIGD could create a significant drag on the market’s performance.
Minimize performance drag from riskier countries
The riskiest countries in the EM sovereign index deliver similar returns to the index over the long term— but with higher volatility that leads to a low risk-reward ratio. A risk-aware approach can offer exposure to traditional EM sovereigns while mitigating the risks of the most volatile countries. This strategy may be particularly helpful in the event of a US recession that negatively impacts the emerging markets.
J.P. Morgan Asset Management has developed a proprietary, systematic risk-aware approach to investing in EM sovereigns with a sophisticated quantitative process. At the core is a rigorous risk screen to identify and exclude the highest-risk countries (Exhibit 5).
A traditional EM debt index contains many small countries and bonds that do not necessarily impact returns but can significantly impact transaction costs. The liquidity filter removes bonds with face amount lower than USD 1 billion and maturity lower than one year. The process then assesses each country's aggregate risk level, ranks them accordingly and removes the riskiest 10% of the market capitalization.
Next is the crucial credit stabilization step where securities are re-weighted to achieve a targeted risk allocation of 75% high yield and 25% investment grade credit. This approach ensures sufficient exposure to the higher-quality high yield segment, a particularly attractive component of the index.
The net result is the JPM EM Risk-Aware Bond Index that captures the upside during favorable market conditions and remains resilient during market selloffs. This quantitative process of excluding riskier countries has proven highly effective. Since its inception in January 2018, the JPM EM Risk-Aware Bond Index has held only two issuers during default events while the broader EMBIGD had 15 defaults during the same period.
The JPMorgan USD Emerging Markets Sovereign Bond ETF (JPMB) tracks the JPM EM Risk-Aware Bond Index and offers investors access to core emerging market debt exposure that balances risk and reward through a precisely defined and tested process. Minimizing exposure to the riskiest parts of the EM sovereign bond index may be an appropriate strategy for investors concerned about a U.S. recession and its impact on emerging markets.