3 reasons to allocate to short-term emerging market debt

Emerging markets are an opportunity for bond investors to mitigate portfolio risk without sacrificing performance

Unlike developed countries, emerging market (EM) countries haven’t experienced the full force of volatility following US President Donald Trump's tariff policy in April this year. They have exhibited lower debt levels than developed countries, and contrasting monetary and fiscal orthodoxy.

Moreover, their average Investment Grade ratings contrast with the unprecedented levels of debt and public deficits in some G7 countries, which have been punished by both the markets and rating agencies. Confident in their solvency and praising their debt reduction efforts, the latter have upgraded more emerging market issuers’ ratings than they have downgraded over the past two years.

For bond investors seeking yield and a moderate appetite for risk might therefore find EM debt attractive area of focus, for three reasons:

1.    A growing weight in the global economy

Firstly, growth prospects in EMs are higher than in developed countries¹. Over the past few decades, globalisation has changed the economic balance of power between developed and emerging countries.

Increasingly integrated into global markets and supply chains, EM countries, led in particular by China, the world's second largest economy, and India, account for a growing share of global GDP. While it is too early to talk of decoupling, EM countries are nevertheless continuing to seek economic and financial independence from developed countries. The intensification of trade and foreign direct investment within the bloc of EMs is contributing to this.

2.    Attractive returns, well-compensated risk

Furthermore, short-term EM debt offers an attractive and sustainable risk/return profile, as evidenced by a long-term comparison of this bond sector's performance with that of a risky asset.

Over an 18-year period (2007-2025), a 1-5 year EM debt index unhedged in EUR posted an annualised performance comparable to, and slightly higher than, that of a US high yield index (5.42% vs 5.03%), with lower annualised risk (8.61% vs 9.58%) and, above all, a maximum drawdown almost three times lower (-12.21% vs -34.88%)¹.

The risk taken by a creditor to an emerging market issuer in the short term is therefore well rewarded. As Narimane Agha, Director of Investment Advisory at Natixis IM Client Solutions Group, puts it, “Short-term emerging market debt is underappreciated”.

Source: Natixis IM CSG, Bloomberg, MSCI, Merrill Lynch ICE, September 2025

Moreover, the credit risk premium for Investment Grade-rated bonds in EMs, although declining, has remained higher than their US counterparts for more than five years.

Valuations

Persistent Premium in EM Corporate Credit (IG)

Source: Bloomberg, October 2025. EM IG Corp = JP Morgan CEMBI BD IG SPread Index, US IG Corp = Bloomberg US Corporate Index

 3.       Greater diversification, reduced portfolio risk

Finally, short-term EM debt stands out from other asset classes due to its potential for decorrelation within a portfolio, not just to equities.

“This bond segment is by far the most diversifying in a typical European wholesale's bond portfolio, and also the least volatile,”  Narimane explains. “The emerging credit market is wrongly perceived as narrow. On the contrary, it offers great diversity in terms of opportunity set, credit quality, geography and issuer type.”

Source: Natixis IM CSG, Bloomberg, October 1, 2022 - September 30 2025 . Performance data quoted represents past performance and is no guarantee of future results.

Exposure to short-term EM debt also reduces the realised risk of the portfolio, particularly due to its short maturity, which limits interest rate risk. The data refutes the commonly held belief that EM investors are exposed to increased volatility and political and geopolitical risk.

Narimane adds: ”We have broken down the short-term EM debt risk into three factors: the USD/EUR exchange rate, EM credit spreads, and 1-5 year US Treasury bills. The three factors are completely uncorrelated. In fact, over nearly two decades, they have even been negatively correlated.”

From March 2007 through to May 2025, the average correlation between EM credit spreads and the USD/EUR exchange rate and 1-5 year US Treasury bonds has fallen by -34% and -29% respectively¹². 

The negative correlation between EM debt and the dollar and US Treasury bonds would, for example, allow an investor to take advantage of a weak dollar and concerns about US debt.

In short, markets can be susceptible to geopolitical, budgetary and tariff uncertainties – just look at the S&P 500 this year – and they can fall very low and rise very high in a short period of time. In this volatile environment, exposure to EM debt can be a good volatility hedge, helping investors to reduce their portfolio risk without sacrificing performance. And the ongoing global geopolitical and economic restructuring is more favourable to certain EM countries, which should only serve to support this trend.

Written in November 2025