Emerging-Market Bonds: Are Returns Worth the Risk?

Emerging-market local-currency bonds have rallied sharply since last October, along with other risky segments of the global bond market. With global economic growth stable or improving, inflation pressures easing, and central banks cutting interest rates or approaching rate cuts, there is room for the trend to continue.

In a benign economic environment, investors are often willing to stretch into riskier segments of the bond market in search of higher yields. However, emerging-market (EM) local-currency bonds typically are more volatile and carry higher risks than developed market bonds. Navigating the market can be challenging, and many investors may prefer to use funds or other professional management strategies when investing.

What are local-currency EM bonds?

The EM local-currency bond universe is diverse and changes over time. It contains bonds issued by governments and government agencies, as well as corporations in their home currencies. There are two broad types: bonds denominated in U.S. dollars, euros, or currencies of other major developed countries—also known as "hard-currency" bonds—and "local-currency" bonds, which are denominated in the issuer's home currency. Yields on hard-currency EM bonds tend to be higher than on local-currency bonds because some lower-rated issuers aren't able to find buyers for their home-currency debt due to a history of depreciation and/or default. Local-currency bonds typically offer somewhat higher yields, offered by somewhat less-risky issuers. Yields reflect the rates set by the issuers' central banks. All else being equal, policy rates tend to be higher in emerging-market countries than in developed markets.

There are different indices that track these markets. If you are buying a fund or index-tracking exchange-traded fund (ETF), it's important to know what's in the underlying index because there can be large variations in yields, duration, and risks, and those differences can affect the return of the investment. In our view, the risk/reward in the hard-currency EM group doesn't look especially attractive. Yields are relatively low compared with developed market yields.