Home Insights Fixed income Expand horizons for yield

Expand horizons for yield

Case for emerging market debt (EMD)

March 6, 2025 | 3 min read

Under-owned EMD creates value opportunity

As a result of challenging and volatile conditions in the past few years, investors redeemed their emerging market debt (EMD) holdings throughout 2022 and 2023, the largest outflow since 20081. This retreat occurred despite growing interest in fixed-income investments globally, as investors remain cautious about EMD exposure. However, this current under-allocation to EMD may become advantageous for the investors who recognize improving fundamental conditions.

Explore Principal Finisterre Emerging Markets Total Return Bond Fund

Emerging markets (EMs) ex-China: Remarkably resilient fundamentals

A much brighter environment for EMD may be on the horizon:

  • Year-over-year growth trended around 3-3.5% annualized in 2024, up from 2.5% in early 2023.
  • Inflation challenges were contained earlier than in most developed markets, thanks to much more decisive tightening by EM central banks starting in early 2021.
  • Commodity prices continue to trade in a “Goldilocks” range, and fiscal balances remain broadly sound to support many EM economies. For example, despite prospects for lower oil prices into 2025, oil at $70-80/barrel is neither too expensive to cause balance of payment challenges for importers nor too cheap to exert major fiscal pressures on exporters.
  • The Federal Reserve’s rate-cutting cycle is coinciding with a measured slowdown in U.S. activity.

Income continues to drive EMD returns

Over the past 20 years, while EMD investors earned an attractive and diversified income stream, it was accompanied by substantial volatility, including numerous instances of capital loss. Income remained relatively stable despite declining global bond yields, significant EMD volatility, and little to no capital gains. Looking ahead, we believe income should continue to anchor returns in both hard and local currency assets.

Average annual income is substantial compared to capital gain return
Since 2003, the income generated by hard and local currency sovereign bonds accounted for nearly all their annualized returns, on average.

Average annual income vs. capital gain return

Annual capital returns from EM sovereigns external and domestic debt indexes. Source:  JP Morgan, Principal Finisterre. Data as of December 31, 2023. Hard currency sovereign bonds is represented by the JP Morgan Emerging Market Bond Index Global Diversified, local sovereign currency bonds is represented by the JP Morgan Government Bond Index - Emerging Markets.

Active management in EMD: A total-return approach

We believe the typical approach of investing in EMD through benchmarked funds generates undue volatility and historically failed to harness the true sources of value in the asset class. Our flexible approach invests across the diverse EMD universe, seeking to provide a high level of total return over the market cycle while also managing downside risk.

Ways to implement our strategy in a portfolio:

  • Diversify portfolios with EMD due to its relatively low correlation versus most traditional asset classes.
  • Boost yield and potential for strong risk-adjusted and absolute returns compared to other spread products.
  • Replace passive exposure with active management to help navigate market cycles and allocate across the full spectrum of EMD opportunities.

Explore Principal Finisterre Emerging Markets Total Return Bond Fund

Portfolio management

Principal Finisterre

As a specialist emerging market debt manager committed to delivering solutions that can perform in any market condition, we utilize an unconstrained, time-tested approach to managing income, volatility, and liquidity.

Chief Investment Officer
Damien Buchet, CFA
31 years of experience
Senior Portfolio Manager
Christopher Watson, CFA
24 years of experience
Learn more

Looking for other ways to put cash to work?

Seek income and optimize yield.

Explore more income ideas

Fixed income
Disclosure

1 Source: Morgan Stanley Research, EPFR. As of December 6, 2024. EM cumulative flows since 2004.

Carefully consider a fund’s objectives, risks, charges, and expenses. Contact your financial professional or visit www.PrincipalAM.com for a prospectus, or summary prospectus if available, containing this and other information. Please read it carefully before investing.

All figures shown in this document are in U.S. dollars unless otherwise noted.

Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. 

Asset allocation and diversification do not ensure a profit or protect against a loss.

International investing involves greater risks such as currency fluctuations, political/social instability, and differing accounting standards. Emerging market debt may be subject to heightened default and liquidity risk. Risk is magnified in emerging markets, which may lack established legal, political, business, or social structures to support securities markets. Fixed Income investments are subject to interest rate risk; when interest rates rise, the price of debt typically declines. International investing involves greater risks such as currency fluctuations, political/social instability, and differing accounting standards.

Principal Funds are distributed by Principal Funds Distributor, Inc.

© 2025 Principal Financial Services, Inc., Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc. Principal Asset Management℠ is a trade name of Principal Global Investors, LLC.

MM10787WA | 03/2025 | 4269665-032026