Emerging Market Debt: Time to Rethink Old Assumptions?

In a recent discussion with Asset TV, I was asked whether pension schemes should be giving emerging market debt a more prominent role within their investment strategies. It is a topic that continues to generate debate, with opinions often shaped as much by historic perceptions as by current realities.

For many years, emerging market debt has been viewed as a specialist asset class, associated with higher levels of perceived risk and volatility than traditional developed market investments. While those perceptions may once have reflected reality, investment markets have evolved considerably.

The question for trustees today is whether our perceptions have evolved with them.

A Changing Investment Landscape

The context for this discussion is important.

Many defined benefit pension schemes are entering a very different position from the one they found themselves in just a few years ago. Funding levels have improved significantly, enabling trustees to think differently about portfolio construction and the role various assets can play in supporting long-term objectives.

At the same time, investors are operating in an environment where valuations across many traditional credit markets appear stretched. As schemes search for diversified sources of return and income, emerging market debt is attracting renewed attention.

What is particularly interesting is how the conversation has shifted. The debate is no longer simply about whether trustees should take exposure to emerging markets. Increasingly, the focus is on how the asset class can be used effectively within a broader portfolio.

The Case for Diversification

From a trustee perspective, diversification remains one of the strongest arguments for considering emerging market debt.

Much of what we do as investors is about balancing risks, reducing unnecessary concentrations and ensuring portfolios are exposed to a broad range of return drivers. Emerging market debt can contribute to all three objectives.

The emerging market universe has grown substantially over the past decade. Many economies that were once considered emerging now represent significant parts of global growth and investment activity. As that universe has expanded, so too has the opportunity set available to investors.

When viewed alongside developed market credit, emerging market debt can offer an alternative source of income and diversification at a time when opportunities in more traditional areas may be harder to find.

The Perception Gap

One of the challenges for emerging market debt is that perceptions often lag reality.

Trustee boards naturally bring different experiences and perspectives to investment discussions. For some, emerging markets still carry associations with political instability, weaker governance standards or periods of market stress. These concerns should not be dismissed, but neither should they prevent us from assessing the asset class based on current fundamentals.

In many respects, the gap between developed and emerging markets has narrowed significantly over time. Yet perceptions of risk have not always adjusted at the same pace.

As trustees, it is important that we continually challenge our own assumptions. Investment decisions should be informed by evidence and long-term objectives rather than historical labels.

Understanding the Role in the Portfolio

Of course, the real question is not whether emerging market debt is good or bad.

The more important question is what role it is expected to play within a scheme’s portfolio.

For some investors, hard currency emerging market debt may sit naturally alongside other credit allocations, providing diversified income and access to a broader investment universe. For others, local currency exposure may offer an additional source of diversification and return potential, albeit with different risk characteristics.

As with any investment decision, the answer will depend on the scheme’s objectives, governance framework and appetite for risk.

What matters is having clarity around the purpose of the allocation and ensuring it aligns with wider investment goals.

Looking Ahead

Emerging market debt is unlikely to be the right answer for every pension scheme. However, as funding positions remain strong and trustees continue to review how portfolios can deliver resilient outcomes, it is an asset class that deserves careful consideration.

For me, the most compelling aspect of the debate is not the potential for additional yield, although that remains important. It is the opportunity to access a broader and increasingly mature range of credit markets at a time when diversification has never been more valuable.

Trustees should always be willing to challenge conventional thinking. When it comes to emerging market debt, doing so may reveal opportunities that many schemes have historically overlooked.

As the investment landscape continues to evolve, trustees need to ensure their governance frameworks and investment strategies evolve alongside it.

At IGG, we support trustee boards in navigating these decisions and delivering long-term value for their schemes.

If you would like to discuss, please get in touch tim.giles@weareigg.com.

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