Emerging-market bond ETFs can play a different role than many investors assume. In a diversified fixed-income allocation, the key question is not whether EM debt is “risky” in the abstract, but what kind of risk it adds. Hard-currency sovereign and corporate exposure can behave differently from domestic-rate bond funds, making it more of a spread-and-credit allocation than a pure rate bet.
That distinction matters for portfolio construction. Investors who already own broad aggregate bond funds may have very little EM exposure, even though the market is large and economically important. Adding a dedicated EM bond ETF can therefore change the shape of the portfolio more meaningfully than a small tilt inside a benchmark-heavy core fund.
Structure also deserves attention. Many EM bond ETFs use hard-currency securities, which can reduce direct local-currency volatility but still leaves investors with sovereign and issuer credit risk, changing spreads, and sensitivity to global liquidity conditions. For long-term holders, the main decision is often whether they want exposure to the borrowers themselves, the local currencies, or both.
Finally, duration and rebalancing discipline matter. An EM bond ETF with intermediate duration can add income potential, but it also means price sensitivity to rate moves remains part of the ride. Because credit conditions and country weights can shift over time, investors may want to treat the allocation as a deliberate satellite or core diversifier rather than a set-and-forget substitute for all bond exposure.
Many fixed income investors know a little something about emerging markets debt. After all, it’s a hard asset class to ignore as it accounts for more than a quarter of the global fixed income market. However, that prominence isn’t adequately reflected in many old guard fixed income funds where EM bonds account for just small portions of the portfolios. Said another way, investors hoping for decent portions of emerging markets debt (EMD) in global aggregate bond funds may be left disappointed.
That disappointment is arguably the result of some antiquated thinking. Many global aggregate bond funds debuted when EM bonds were volatile and seen as a rough-and-tumble asset class reserved for yield-hungry, risk-tolerant professional investors. But times change, and so should perspectives.
“However, we also believe it’s due to outdated thinking about EMD, which has matured from a fundamental and credit quality standpoint, and offers compelling characteristics relative to developed market peers,” noted the emerging markets debt team at Neuberger. “Either way, we believe it is time to reconsider emerging market exposures, and potentially introduce EMD as a distinct core allocation within broadly diversified portfolios.”
Fabulous Fundamentals
Experienced fixed income investors know that, in broad terms, EMD has experienced some tumultuous periods. However, many of the most dubious default examples (Argentina, Thailand, among others) were specific to individual countries. Moreover, many developing economies, even plenty of smaller ones, now have vastly improved fiscal situations compared to 30 or 40 years ago.
“Today, however, the EMD universe presents a far more balanced picture,” the Neuberger team said. “This year, real EM GDP growth is expected to more than double developed markets, but inflation forecasts are lower, while measures of trade balance, fiscal deficits and debt/GDP are comparable or more favorable.”
Another source of allure with this corner of the bond market is the steadily improving credit quality, which implies lower risk for investors.
“A constructive economic backdrop has been part of the reason the EM credit environment has seen steady improvement since the COVID-19 pandemic, with sovereigns showing particular gains over the last couple of years, as reflected in positive credit rating changes,” according to Neuberger. “Meanwhile, leverage of investment grade EM credits has remained stable at levels substantially lower than 10 years ago, and barely a third of the levels seen in the U.S. and developed markets more broadly.”
The firm issues the Neuberger Emerging Markets Debt Hard Currency ETF (NEMD), which has a 30-day SEC yield of 5.65% and a duration of 6.66 years.
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