- In 2025, emerging market debt funds returned to positive inflows, especially local currency strategies
- Emerging market debt accounts for approximately 11% of the global bond market
- Managers are positive on this asset class, but investors need to be selective
Why investors are returning to emerging market debt
Investors are returning to emerging market debt markets. There have been tentative signs of this in recent months, when this asset class recorded positive inflows.
In particular, from May to October 2025, emerging market debt strategies in local currency raised €5.62 billion in Europe, according to Morningstar estimates. Those in hard currency recorded their first positive inflows in July and raised around €3.49 billion in three months.
Emerging market corporate bond funds also performed well, particularly those hedged against euro exchange rate risk.
Emerging market debt has been at a disadvantage compared to other fixed income segments since 2022, as investors have preferred less risky bonds amid fears of recession and worsening geopolitical conditions. But things are changing.
Some managers surveyed by Morningstar believe that investors may start to diversify their portfolios outside the US, which would benefit emerging market bonds. “However, it remains to be seen whether the recent flows will stabilize,” says Evangelia Gkeka, senior analyst on Morningstar’s Manager Research team.
Emerging market debt: size, growth, and weight in the global market
Despite being an unpopular asset class after the Covid-19 pandemic, emerging market debt accounts for about 11% of the global bond market. Over the past 15 years, its size has grown from about $2 trillion to the current $9 trillion. The largest share is represented by local currency debt, mainly sovereign issues, which have a market cap of around $6.7 trillion (data as of August 2025). In recent years, the entry of China and India into the local currency segment has contributed to its growth, while the hard currency segment has not seen a significant increase.
“One of the reasons behind the growth and dominance of local currency bonds is that many countries prefer this type of issuance because they are less vulnerable to foreign investment flows and involve lower currency risks,” explains Gkeka.
Local currency or hard currency? The differences for investors
From an investor’s perspective, the decision to invest in hard or local currency or a mix of both depends on investment objectives, the role of these assets in the overall portfolio allocation, and appetite for credit, currency, and country risk.
After the sell-off in 2022, emerging market debt rebounded, thanks to the success of central bank policies in raising interest rates to combat inflation. Improved economic dynamics, attractive yields, and low default rates also contributed.
Risk and default rates: how emerging market debt performs
Over the past decade, sovereign and corporate bonds denominated in hard currency have had lower default rates than US high-yield bonds. However, default rates on emerging market high-yield corporate bonds have been higher, due to Russian corporate bonds and the Chinese real estate sector.
The universe of local currency sovereign bonds has not experienced any significant defaults in the last decade, with the exception of 2022.
“Over the past ten years to December 2024, based on estimates from the managers we cover, the average default rate for sovereign and corporate bonds in hard currency stood at 1.9% and 1.3% respectively, lower than the US high-yield market average of 2.6%,” notes the Morningstar analyst.
In terms of credit quality, sovereign debt in local currency is generally better than that in dollars or other hard currencies. In fact, most hard currency issues are from countries that are highly dependent on exports or have lower ratings, which would make it difficult for them to attract investors otherwise.
Approximately 81% of the local currency universe has investment-grade ratings, while 19% is high yield. In contrast, the Morningstar sovereign hard currency index comprises approximately two-thirds investment-grade securities and one-third riskier issues.
In terms of duration, emerging market sovereign debt in hard currency tends to have longer average maturities of around 7.3 years compared to local currency government bonds (5.9 years) and hard currency corporate bonds (5.4 years).
Is now a good time to invest in emerging markets?
Emerging market bond markets have performed well, but sluggishly over the past five years. The sell-off in 2022 was particularly damaging. Investors exited the asset class after Russia’s invasion of Ukraine due to fears of inflationary flare-ups and recession. In 2023, however, emerging bond indices outperformed investment-grade indices but lagged slightly behind high-yield indices.
Performance was solid in 2024, with the exception of local currency debt, and in 2025, when emerging market local currency issues benefited from dollar weakness and the recovery in risk assets from mid-April.
According to managers surveyed by Morningstar, emerging market bonds offer attractive yields even though spreads have narrowed in recent years.
“After a long period of very low interest rates following the 2008 global financial crisis, rate increases in 2022-23 have led to higher coupons for emerging market bond investors. According to several emerging market bond managers rated by Morningstar, despite the recent narrowing of spreads, higher base interest rates and resilient fundamentals result in an attractive total return profile for investors. However, it is important to be active and highly selective, as different risk factors (e.g., inflation, trade tariffs, commodity prices, and geopolitical risks) have different impacts from country to country,” concludes Gkeka.
