By Thomas Haugaard, Portfolio Manager on the Emerging Markets Debt Hard Currency (EMD HC) Team at Janus Henderson Investors.
Key takeaways:
- The hard currency emerging market sovereign universe (EMD HC) is now a mature asset class spanning over 70 countries across the full ratings spectrum, with over 50% rated investment grade. The breadth of countries brings fundamental diversification of risk within an investor’s portfolio.
- EMD HC provides investors with access to the EM ‘risk premium’ combined with the more defensive properties of bonds.
- Investment outcomes can be enhanced through active management due to the complexity of the asset class and prevailing market inefficiencies.
Key misconceptions about Emerging Markets (EM)may be preventing investors from embracing this asset class, particularly in hard currency EM sovereign debt. EMD has evolved into a rapidly growing and maturing asset class that warrants closer attention from investors seeking diversified and resilient portfolios with attractive long-term return potential.
Here are eight of the most common myths that may be holding investors back from taking advantage of this growing and maturing asset class:
Myth 1: Currency and rate volatility erodes EM returns
The primary drivers of return for EMD HC are US Treasury (UST) yields and sovereign credit spreads – given it is a ‘credit’ asset class. Any significant impact from currency depreciation is typically linked to country-specific factors and has become much less important for the broader asset class as the share of domestic debt has increased. US dollar moves result in secondary effects. Rather than being systemic to the asset class, these moves tend to impact credit quality only for smaller frontier countries where HC debt is the dominant source of funding and when there is a large and sustained depreciation in a country’s currency due to economic crisis. This contrasts with EM local currency (LC) bonds, where moves in EM currencies versus the US dollar are often the main driver of performance. As the US dollar tends to move in long cycles, this explains the disappointing returns over the last decade for LC EMD investors in US dollars. This headwind has not been the case for EMD HC investors.
Myth 2: Emerging markets are hampered by low credit ratings
The EM sovereign universe looks very different to the 1990s when the asset class was in its infancy, reflecting growth and economic development. The percentage of investment grade (IG) bonds in the major benchmark indices has risen from under 10% in the mid-1990s to over 50%. Alongside this expansion, credit quality has improved; the average credit quality of the index has risen from BB- in 2000 to just above BB+ in 2025.
Putting this in perspective, the long-term return profile for EMD HC has been comparable to US high yield (HY) corporate debt. However, the credit quality is multiple notches higher, with over half of the EMD HC investment universe rated IG as explained earlier. It is also worth noting that the inflation shock of 2022 had an outsized impact on total returns in EMD HC due to the relatively long duration of the asset class.
Myth 3: EM countries lack investment stability
The landscape of investable EM countries has expanded dramatically to over 80 countries today, of which 68 are included in the main EMD HC index.
The outdated view that EM countries are plagued by political instability and economic volatility doesn’t hold up against recent improvements in economic fundamentals, which are often overlooked. Over the past two decades, EM sovereign financial health, including debt levels and fiscal deficits, has shown relative improvement compared to DMs. With stronger growth potential and lower debt levels, EMs are in a better position to manage and sustain their debt.
Additionally, EM countries have been proactive and effective in their monetary policy responses to inflation, especially post-COVID showcasing their resilience. This is in stark contrast to the situation in DMs, where issues of long-term debt sustainability and political instability are becoming more apparent and driving volatility. The distinction between DM and EM bond markets is becoming increasingly blurred.
The sovereign credit ‘anchor’ in EMD HC has helped to limit drawdowns versus other EM asset classes, such as EM local currency (LC) debt (driven by currency risk) and EM equities, which are more reliant on growth differentials. In our view, EMD HC can act as a core allocation for investors because it provides access to the EM risk premium along with the more defensive properties associated with bonds.
Myth 4: EM is too risky due to defaults and restructurings
Restructurings have historically resulted in reasonable recovery rates (more than 50%) as sovereigns cannot disappear (unlike corporates that can go into bankruptcy) and need to maintain good relationships with investors to keep market access. Generally, defaults have been concentrated among smaller issuers in the index, including during the COVID pandemic. Such ramifications of the pandemic were not by any means limited to EMs. Over the past three years, sovereign rating upgrades have exceeded downgrades.
EM restructuring efforts also merit attention. Participation in International Monetary Fund (IMF) programmes encourages countries to implement structural reforms and specifically commit to disciplined fiscal planning and borrowing, facilitating sovereign development responsibilities. Notably, several countries in IMF programmes have completed their required restructuring in 2024–2025 and no longer require programme support or are in the process of renegotiation. This highlights both the discipline of EMs in securing and completing a programme and the value of IMF support. Several frontier economies have undergone a multi-year reform process in partnership with the IMF and are no longer in need of further funded programmes, but retain the option to go back to the Fund should future shocks were to emerge.
We also hear concerns about EM ‘event risk’, which is the potential impact that a country-specific issue can have on an investment portfolio. While there are fewer EMID HC issuers than in a corporate credit index, there are around 60 countries represented in our portfolio.⁶ A firm belief we have is that country diversification is very important to mitigate event risk, which is why, in contrast to some other active managers, we do not believe in running a concentrated portfolio or subset of ‘best ideas’. That way, we aim to be more resilient to event or sentiment swings in one country or another.
Myth 5: Commodity weakness will be a big problem for EMD
Higher commodity prices are often viewed as uniformly negative for emerging markets, but this oversimplifies a highly diverse asset class. In practice, commodity price moves tend to drive differentiation across EMs given the different make-up of their economies, rather than creating a systemic headwind.
The impact of higher commodity prices varies significantly across countries and commodities:
- Net energy trade position: Commodity exporters can benefit from stronger fiscal revenues and improved external balances, while large net importers may see pressure through weaker trade balances, inflation pass-through and wider spreads.
- Exposure goes beyond oil: EM commodity production spans energy, metals and agricultural goods, each with distinct demand drivers and price cycles. Energy exporters are the larger share of the JP Morgan EMBI Diversified Index, followed by metals and agriculture.
- Outcomes are country specific: The net impact depends on trade balances, energy intensity, subsidy and tariff regimes, policy responses and macro resilience.
This dispersion reinforces the importance of active management. Assessing country level fundamentals and commodity sensitivities is key to distinguishing relative winners and losers during periods of elevated commodity price volatility, particularly in geopolitically uncertain environments.
Myth 6: Event risk and 2022 performance is a reason to avoid EMD
The recent move higher in yields in 2026 may be concerning to some as reminiscent of the 2022 period. However, it is worth noting that UST yields also act as a buffer for EMD HC because credit spreads and underlying Treasury yields often move in opposite directions. In a risk-off environment, falling UST yields can offset widening spreads and vice versa, stabilising total returns in EMD HC. There are periods where correlation is positive between rates and credit spreads, but this tends to be temporary. EMs have improved their fundamentals and reduced external vulnerabilities, with economic growth outpacing that of the US and expected to continue to do so in the coming years. In our view, a stronger USD now has more limited direct credit impact on EM assets because of increased domestic issuance in local currencies, larger FX reserve buffers, more credible macro policy frameworks, and diversified trade linkages away from the US.
Myth 7: Passive funds provide efficient access to this market
Despite some passive funds offering EM exposure, the complexities and costs associated with replicating the index underscore the limitations of passive strategies. Index benchmarks are designed to serve as comprehensive and efficient metrics that accurately reflect a defined market, ensuring that they are investable, measurable, and clear. To achieve this, benchmark providers implement strict eligibility criteria for inclusion in their indices. Consequently, the construction of these indices is governed by rules that prioritise liquidity over maximising of returns. Such investors are constrained in buying USD bonds that are index eligible to minimise tracking error, which misses many potential opportunities.
Active management can capture opportunities overlooked by passive strategies, such as:
- Non-index eligible bonds that do not meet the maturity/size/ratings criteria for index inclusion.
- Off-benchmark sectors, such as sub-sovereigns (provincial or municipal issuers), supranationals, majority-government-owned companies and corporates.
- Non-USD denominated bonds like euro-bonds (dominant in Eastern European and certain West African countries).
The existence of investor constraints and market segmentation enables us to often discover better risk-adjusted returns in non-benchmark eligible securities of the same issuer, or in smaller or less well-researched countries that are neglected by mainstream investors. We frequently find profitable opportunities to buy bonds denominated in other hard currencies, such as euros, of the same issuer and pick up an enhanced yield after factoring in FX and rates hedging. The recent increase in issuance of euro-denominated bonds from EM countries has expanded the opportunity set.
Myth 8: Bottom-up analysis works better for companies versus countries
Traditionally, debt investors have leaned toward corporates, perhaps attracted by the perceived higher alpha opportunities. However, the EM sovereign landscape, encompassing a broad array of countries at various stages of socioeconomic development and possessing distinct characteristics, offers a rich tapestry of investment opportunities. This complexity and the inherent inefficiencies within the EM sovereign universe challenge the notion of viewing these entities as a homogeneous group.
The inefficiencies within the EMD HC sovereign space present substantial opportunities for capital compounding over time through the realisation of additional alpha. Moreover, while both EMD sovereign and corporate entities fall within the credit asset class, the sovereign universe’s breadth provides a robust foundation for fundamental diversification within an investment portfolio.
A more resilient EM
In conclusion, the EMD HC asset class presents a compelling long-term investment opportunity, despite prevailing misconceptions. This paper has elucidated the robust attributes of EMD HC, such as attractive yields, resilience, diversification benefits, and the advantages of active management.
