Emerging market debt is making a comeback

It has been a rather turbulent start of the year so far. The Iran conflict initially caused the US dollar to strengthen, weakening emerging markets currencies and leading to higher local yields due to the inflationary impact of rising energy prices. However, emerging market debt once again proved to be relatively resilient. Markets have since stabilised, with risk premia on government bonds returning to pre-conflict levels, supported by strong investor demand.

 The latter is interesting considering that investors were largely unfazed by the volatility surrounding the conflict. Local markets have also rebounded, although currencies remain weaker and rates structurally higher following the inflation shock. Against this backdrop, portfolios have generated positive alpha year-to-date through active positioning and selectivity. Despite recent volatility, we think that emerging market debt continues to offer attractive opportunities.

We have the witnessed this positive momentum at AllianzGI – in terms of institutional as well as the wholesale flows – which sets a great foundation for the team to build on in 2026.

We expect inflows into the asset class and our products to continue. Fundamentals in emerging markets are improving. Many emerging economies today have stronger fiscal positions, more credible monetary policies and more resilient institutions than in the past. Several have adopted independent central banks and more disciplined budget frameworks, which has helped reduce volatility and strengthen investor confidence. At the same time, default risk has fallen sharply, and even when isolated defaults do occur, the asset class is now so broad and diversified that they rarely spill over across markets.

Indeed, we have seen zero defaults in the past couple of years, a trend we expect to continue. Rating agencies have recognised this progress through a wave of sovereign upgrades, reflecting the improved risk profile of the asset class – a shift many investors have welcomed. Last year, I covered these trends in an article about lessons learned over 30 years of investing in this asset class.

The key points to mention are the rare combination of high income, improving credit quality and a constructive macro backdrop. On income, following a repricing of global fixed income markets over the past few years, overall yields for emerging market sovereign bonds are closer to multi-year highs than lows, which is very positive.

Moreover, emerging market debt can play an important role as a diversifier in portfolios. Its relatively low correlation to other asset classes can make it a valuable element of an efficient core allocation. Achieving the right balance requires careful attention to fundamentals, liquidity conditions and the evolving macro environment. 

Most risks are external to emerging market countries themselves. Continued high energy prices would increase inflationary risks, contributing to a stronger US dollar – clearly that would be a headwind. Additionally, market sentiment could be affected by concerns around AI-related equity valuations and the potential for bubble-like dynamics. Furthermore, there are some elections taking place in 2026, particularly in Brazil towards the end of the year and in Colombia in mid-2026, which might create some uncertainty in those countries.

Yet despite these risks, the breadth of the asset class reduces the likelihood that a single country event could trigger widespread contagion.

Given the diversity of issuers and the presence of both structural and cyclical influences on the asset class, active selection will be key. More than 70 countries now issue emerging market debt and the market is worth about USD 25 trillion – roughly a quarter of global fixed‑income issuance.¹ We believe macro drivers ultimately dictate asset‑price performance. That’s why avoiding underperformers matters just as much as identifying winners. Our high‑conviction approach means we are fully prepared to hold zero exposure to countries where we see macroeconomic or valuation headwinds, regardless of benchmark weight. 

To achieve this, a team that has experience through several cycles is crucial. Our emerging market debt team has 17 years of average industry experience and covers the investment universe depicted below (Exhibit 1). We have a strong seven-year track record in relation to both the key indices², which demonstrates the strength of our investment philosophy and the team’s expertise. 

I believe we are well positioned to make 2026 a successful year for emerging market debt at AllianzGI, and I am looking forward to seeing what we can accomplish together. 

1 Source: BofA Global Research, BIS, Bloomberg, JP Morgan as at December 2024
2 JP Morgan EMBI Global Diversified Index and accompanying JP Morgan Equal Weight Index