How to Invest in Emerging Market Debt

Emerging market debt offers an opportunity to tap into the growth potential of developing economies. This asset class consists of bonds issued by governments and corporations in countries with emerging financial markets. While they can offer higher yields than traditional U.S. or developed market bonds, they also come with greater risk. A financial advisor can help you determine how this asset class fits into your investment strategy.

What Is Emerging Market Debt?

Emerging market debt refers to bonds issued by governments or corporations in developing countries. These markets are often characterized by rapidly growing economies, expanding infrastructure and increasing integration into the global financial system. Examples of “emerging” countries include Brazil, India, Indonesia, Mexico, South Africa and Turkey, among others.

The debt from these markets can be issued in two primary ways: 

1. Local currency. Local-currency debt is more sensitive to currency fluctuations, but reflects a growing confidence in the country’s economic stability. 
2. Foreign (usually U.S.) currency. Foreign-currency debt often appeals to international investors because it reduces exchange rate risk for the bondholder, but may increase it for the issuer.

Emerging market debt is known for offering higher yields because investors are taking on the additional risk, including political instability, currency volatility and creditworthiness concerns. The asset class includes sovereign bonds (issued by governments), quasi-sovereign bonds (issued by government-affiliated entities) and corporate bonds.

Ways to Invest in Emerging Market Debt

Below are some of the most common vehicles for gaining access to emerging market debt. Each of these investment options offer a different level of risk, liquidity and exposure:

Emerging Market Bond Mutual Funds

Mutual funds that focus on emerging market debt pool investor capital to buy a diversified selection of bonds from various countries and sectors. These funds are actively managed, meaning a professional team selects and adjusts holdings in response to market conditions, credit quality and currency risk. They often come with high management fees and may have minimum investment requirements or restrictions on trading frequency.

Emerging Market Bond ETFs

Exchange-traded funds (ETFs) offer a low-cost, liquid way to invest in emerging market debt. These funds typically track a bond index, giving investors passive exposure to a broad range of emerging market bonds. Because ETFs are traded on major exchanges, they provide flexibility to buy or sell throughout the trading day, much like stocks. ETFs are a popular choice for investors seeking transparency, diversification and lower costs. However, they may not offer the same level of risk management as actively managed mutual funds.

Individual Emerging Market Bonds

More experienced investors can purchase individual bonds issued by emerging market governments or companies through international brokerages or bond trading platforms. This approach allows for tailored exposure but requires in-depth knowledge of the issuer, economic conditions and currency risks. It also demands a larger investment minimum and active monitoring.

Actively Managed Emerging Market Debt Strategies

Some investment firms offer actively managed portfolios or separately managed accounts (SMAs) focused on emerging market debt. These strategies focus on personalized exposure. They benefit from active risk management, research and hedging strategies when navigating volatile conditions. Firms like PIMCO and Franklin Templeton offer institutional-grade emerging market bond strategies designed for high-net-worth individuals or advisors managing client portfolios. 

Understanding the Risks of Investing in Emerging Market Debt

Emerging market debt comes with a unique set of challenges for investors. Be aware of these four common risks when investing:

• Credit risk.  Some emerging market issuers have lower credit ratings or a history of defaults and restructuring. If a government or corporation fails to meet its debt obligations, investors can face steep losses — even within diversified funds.
• Currency risk. Bonds issued in local currencies expose investors to exchange rate fluctuations. A weakening local currency relative to the U.S. dollar can reduce returns. While some funds offer currency hedging, it adds cost and doesn’t fully eliminate risk.
• Political risk. Political instability, elections, policy changes and geopolitical events can negatively affect bond prices. Investors must stay informed about the various political landscapes involved.
• Liquidity risk. Emerging market bonds may be more difficult to sell quickly, especially during periods of market stress. Limited trading volume or a lack of buyers can lead to unfavorable pricing or delays in liquidating positions.

Bottom Line

Emerging market debt can be a valuable addition to a well-diversified investment portfolio, offering enhanced yield and exposure to growing economies. Whether you access it through mutual funds, ETFs or managed accounts, this asset class presents both opportunity and complexity. While the higher returns are enticing, they come with greater risks — including credit defaults, currency swings and political instability.

Investment Planning Tips

• A financial advisor can help you analyze investments and manage risk for your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you want to diversify your portfolio, here’s a roundup of 13 investments to consider.

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