Time to shine for EM debt
EM fundamentals now speak for themselves. Their strength reflects the increasingly significant role of these economies in international markets – forecast to grow to about 50% of global GDP in US dollar (USD) terms, and 60% in terms of Purchasing Power Parity.1
This influence is to be expected given supportive macro dynamics. External sector and public finances are improving, with trade balances and FX reserves both on positive trajectories. In turn, the latest IMF forecast suggests EM and developing economies will continue to be global growth drivers, with expectations they will expand by 4.2% in 2025 and 4.0% in 2026.2
They are also enjoying positive credit ratings momentum as upgrades outpace downgrades. As a result, EM hard currency sovereigns had returned 10.6% year-to-date as of mid-September, while corporates had gained 7.2%.3
They are also enjoying positive credit ratings momentum as upgrades outpace downgrades. As a result, EM hard currency sovereigns had returned 10.6% year-to-date as of mid-September, while corporates had gained 7.2%.
Weighted average ratings of EM indices
Source: BAML as of December 2024 and RHS chart as of June 2025; L&G.
EM perceptions a myth
On the evidence of the data, we believe many emerging economies can no longer be viewed as second-best to some of the so-called developed market (DM) nations. Indeed, with sound policies being implemented across various EM countries, they look increasingly like DM.
Broadly, for example, inflation is stable across many EM economies, with debt-to-GDP ratios typically below levels in the G7.4 EM central banks have generally handled inflation better than their DM counterparts by recognising it early and not implementing zero or negative rates.
Further, as EM credit ratings have improved over the past two decades, the JP Morgan EMBI Global Diversified Index (sovereign hard currency index) is at around IG rated, while the JP Morgan CMBI BD Index (corporate hard currency Index) is now solidly IG rated.
With all this in mind, we believe now is the time for global investors to reassess their allocation to EM debt.
In particular, EM debt offers a mix of volatility profiles, default rates and drawdown profiles across sovereign IG, sovereign HY, corporate IG and corporate HY.
Capturing EM momentum
Yet despite meaningful inflows into EM debt in 2025 and strong local-currency returns as USD pressure eased and yields in many EMs rallied, credit fundamentals remain mixed. Investors cannot ignore the fact that dispersion across EM countries and sectors is high.
More specifically, there is varying health in sovereign and corporate balance sheets, plus some issuers facing refinancing pressures while others benefit from stronger commodity prices and fiscal buffers. This means credit selection matters, with curve positioning and FX overlay potentially adding value versus passive index exposure.
In their search for value, therefore, investors can choose different parts of the EM universe based on their risk appetite and return requirements.
For example, we have seen since early 2025 that US IG investors have increased their EM allocation preference to 15%, up from 8%.
US IG investors rose to 15% from 8% their EM allocation preference
Y-Axis: EM Allocation (%) / X-Axis: Date
Source: Bloomberg, JPM, BofA as of August 2025.
As EM typically performs well during rate-cutting cycles by the US Federal Reserve and when the USD weakens, these portfolios with increased EM allocations might stand to gain from the current macro backdrop.
Further, when considering potential returns for EM sovereign and corporate indices under different scenarios for rates and spreads, should nothing change much with sovereign EM spreads over the course of a year, investors would make about 6.5% on the sovereign index and 5.9% on the corporate index. Should rates rally but spreads remain unchanged, returns could reach about 8% for sovereigns based on yields falling 50 basis points, and about 8% for corporates based on yields falling 75 basis points.5
EMD returns outlook
(Top chart: Sovereign index / Bottom chart: Corporate index)
Source: Bloomberg, L&G as of 2 Sep 2025.
We believe the investment opportunities in hard currency EM debt are attractive. While local currency could perform well with USD depreciation, many EM countries have already implemented rate cuts, limiting potential gains.
Differentiating EM debt
With an outlook that seems constructive but heterogeneous for 2026, EM debt may benefit in the case of a softer USD and where there is scope for EM rate cuts to support local-currency returns and selective hard-currency opportunities.
However, managing idiosyncratic sovereign and corporate risks, as well as geopolitical and trade shocks, must be front of mind for global investors.
This requires active, high-conviction, diversified positioning with disciplined hedging and country selection as a prudent way to capture upside while controlling tail risk. This approach can help to achieve the goal of a total return-orientated approach with an asymmetric return profile – in short, higher and larger positive returns and lower and fewer drawdowns.
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Sources
1 - There is no guarantee that any forecasts made will come to pass.
2 - Source: IMF, "World Economic Outlook", October 2025 - https://www.imf.org/en/publications/weo/issues/2025/10/14/world-economic-outlook-october-2025
3 - Source: L&G, “Active Fixed Income Outlook”, Q4 2025: chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://am.landg.com/asset/4a91b3/globalassets/lgim/_document-library/insights/afi_outlook_q4_2025.pdf/
4 - Source: Visual Capitalist, “Mapped: Government Debt to GDP by Country in 2025”, October 27, 2025: https://www.visualcapitalist.com/mapped-government-debt-to-gdp-by-country-in-2025/
5 - Assumptions, opinions, and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.
About the authors
Ben
Ben joined L&G’s London team in 2008, initially focusing on credit strategy before taking on the role of Head of Investment Strategy and Research, coordinating L&G’s research from long-term themes to short term market drivers. He also chaired the monthly investment macro meeting for many years, a key input for portfolio risk across the active strategies. He relocated to Hong Kong in 2020, joining the Legal & General Investment Management Asia Limited's Board as a Director and was appointed Head of Investment Strategy, Asia to help grow L&G-Asset Management’s investment business across the APAC region. Ben started his career in 1999 as a credit strategist at Dresdner Kleinwort Benson in London, before performing the same role at both BNP Paribas and Lehman Brothers. He holds a Master of Arts in Mathematics from Queens' College, Cambridge University.
Uday
Uday is responsible for developing active emerging market capabilities for L&G’s Asset Management division. Uday has 30 years of experience investing in emerging market fixed income securities, including hard and local currency sovereign and corporate debt. Uday joined the business in April 2014 from Gulf International Bank (UK) Ltd where he held the title of Chief Investment Officer with primary responsibility for managing the flagship EMD hedge fund and other fixed income portfolios. Prior to that, Uday set up the Bear Stearns’ Eastern European sovereign trading desk in London, and at Merrill Lynch in New York helped build out the institutional customer base and manage the firm’s Latin America exposure. Uday has an MBA in finance from the University of Chicago and a BSc degree in industrial management from Carnegie Mellon University (High University Honors).
About L&G
Established in 1836, L&G is one of the UK's leading financial services groups and a major global investor, with US$1.533 trillion in total assets under management of which 43% (US$654 billion) is international (Source: L&G, global AUM as at 30 June 2025. Excludes assets managed by associates (Pemberton, NTR, BTR). The AUM includes the value of securities and derivatives positions and may not total due to rounding). L&G's Asset Management business is a major global investor across public and private markets. Our clients include individual savers, pension scheme members and global institutions, who invest alongside L&G’s own balance sheet. Our ambition is to be a leading global investor, innovating to solve complex challenges for our clients using the power of L&G. This is rooted in our investment philosophy and processes, which are focused on creating value over the long term.
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