EMD’s Gravity Shift

A return to inflows and strong performance in 2025 reflect how emerging market debt has refined its role, moving from a niche satellite allocation to become a core portfolio component. While developed market government bonds labour amid fiscal strain and supply pressures, strong fundamentals, central bank credibility and attractive real yields are opening investors’ eyes to the long-term opportunities in emerging market bonds.

19 December 2025

For much of the last decade, emerging market debt (EMD) was seen by some investors as a volatile, high-octane - and sometimes even a reluctant - satellite holding, a source of occasional portfolio alpha for those willing to cling on during impromptu rollercoaster rides from time to time.

But, thanks to a combination of changes in macroeconomic, structural and technical factors, EMD can play a very different role for investors nowadays and warrants a very different approach from portfolio allocators.

In contrast to a decade ago, in our view, the asset class now exhibits many of the qualities investors have traditionally demanded from core fixed income allocations: attractive, positive real yields, low default risk, improving credit momentum and an emerging market (EM) policy environment that is broadly supportive for fixed income assets.

EMD macro resilience is no longer a forecast, it is observable reality

We believe that many EMs’ macro resilience and willingness to diverge on policy, such as Brazil raising interest rates in 2021-22 to fight inflation, and easing when the Fed was still tightening in 2023-24, are one of the key pillars of the new era for EMD. For example, even before the geopolitical uncertainties such as trade tariffs associated with the new US administration, EM central banks, including Mexico, Chile and South Africa, as well as Brazil, were quick to act on pandemic-related inflation risks, embarking on hiking cycles as early as 2021 to combat pricing pressures and normalise monetary policy, in contrast their developed market (DM) counterparts. This proactive approach - as early movers, rather than followers of DM central bank orthodoxy - has enhanced EM central banks’ credibility, in our view. Coupled with improvements in EM current accounts and external debt service ratios that lower vulnerability to factors such as a recovery in the USD, EMs have enjoyed their best sovereign credit upgrade cycle in over a decade¹ with Brazil and South Africa among the main beneficiaries. What’s more, local currency real yields in the biggest, most liquid markets, such as Mexico and Brazil, are currently among the most attractive globally at circa 5% and 4.5%* respectively, offering what we believe to be a meaningful element of insulation against unexpected external shocks, inflation surprises and foreign exchange (FX) swings.

Chart 1: EM versus DM 10-year Government bond real yields

31 December 2020 to 30 November 2025

Meanwhile, DM bonds are losing their lustre

In contrast to EMD, DM bonds are shedding their traditional ‘safe haven’ appeal. For example, long-dated US Treasuries, once a mainstay component of traditional 60:40 equity:bond portfolios, have shown an unwelcome degree of higher correlation with stockmarkets since the onset of the Russia/Ukraine war. While this correlation has been most acute during ‘risk-off’ periods, the broad loss of investor confidence in DM bonds largely reflects concerns over fiscal unsustainability in free-spending, high-debt economies. In the case of the US, fiscal slippage from events such as the “Big Beautiful Bill”² and policy uncertainties (eg tariffs stemming from “Liberation Day”³) have further undermined the safe haven appeal of US Treasuries. While the US’s unsustainable fiscal trajectory – with total public debt to Gross Domestic Product (GDP) approaching 125%⁴ - is concerning, the outlook is equally bleak for debt-heavy Europe and Japan, where worrying demographic trends have created structural headwinds from ageing societies, in contrast to the long-term ‘demographic dividend’ that many EM economies are only now beginning to truly benefit from. But in the meantime, present-day fiscal pressures, heavy issuance and sticky inflation mean that DM bond investors face low, or even (occasionally) negative real yields (presently circa +0.3%* in Germany and Japan, and close to zero in Switzerland), compared to the +3% to +5%* available across many EMs.

Investors are beginning to grasp the EMD opportunity

Up until late 2024, EMD had faced years of outflows, reflecting belated post-pandemic monetary policy tightening to combat inflation in DMs, USD strength and general risk aversion that counted against higher-beta EM assets. However, with the Federal Reserve embarking on an ongoing rate-cutting cycle in September 2024, and policy uncertainty stemming from the new Trump administration in early 2025, investor demand for diversification beyond the US has grown considerably. Meanwhile, a remarkable -10.7%* slide in the USD over the first half of 2025, benign EM inflation and more attractive fiscal profiles have increasingly highlighted the appeal of under-owned EMD. So much so that 2025 has witnessed the first sustained inflow cycle (albeit muted relative to history) into EMD for five years⁵. With credit quality across EMD continuing to improve (reflecting zero defaults in 2024-25 and multiple sovereign rating upgrades, eg Argentina and Egypt), we are already witnessing what we believe is a whole new category of buyers of EMD. While traditional holders of EM bonds were largely restricted to specialist EMD investors and local pension funds, we believe that a new wave of inflows from ‘crossover’ buyers – those typically investing in DM fixed income assets, such as government bonds and US investment grade credit – are now alive to the long-term opportunities in EMD, and are gradually making new allocations, or increasing existing portfolio weightings. As demonstrated in the below, we believe that EMD as an asset class is already benefitting from the early stages of a reallocation tailwind as investors switch exposure from DM fixed income.

Chart 2: Flows divergence between EM and DM

After almost three years of outflows, we believe EMD technicals, such as the improving credit ratings cycle and attractive real yields, are set to become a powerful headwind to support inflows.

Cumulative flows into EM and US markets (January 2022 to October 2025)

Why active management can be the enabler to maximise alpha across the differentiated EMD universe

While multiple structural, macroeconomic and technical factors present a convincing case for reallocating from DM to EM debt, the scale and depth of the universe can mean that investors favouring a one-size-fits-all passive approach risk holding only minimal exposure to the most attractive opportunities in a rapidly evolving asset class. For example, the full EMD universe spans no fewer than 90 or so countries (including sovereign and corporate, hard and local currency debt), and around 900 issuers6. Notwithstanding the broad and strengthening case for strategic allocation to EMD, we believe that a specialist, active approach can help to capitalise on opportunities in an asset class where dispersion between countries and issuers remains significant, while selectivity on duration, country, currency and credit quality, as well as local/USD and blend strategies, has the potential to enhance returns.

Nevertheless, we believe that the investment case of EM fixed income allocations is strong. In our view, for the first time in 15 years, EMD combines defensive characteristics with attractive income and growth exposure. For investors who agree that this is the very definition of a core fixed-income allocation, EM bond exposure could no longer be just a satellite portfolio position.

Philip Meier, Deputy Chief Investment Officer and Head of EMD, and Belinda Hill, EMD Portfolio Manager and Managing Director, of Gramercy Funds Management co-manage EMD strategies for GAM Investments.