From mavericks to mainstream. When we began investing in local currency emerging market bonds 20 years ago, many investors still viewed them as a niche trade that required a leap of faith. Today they are a well-established allocation within institutional portfolios.
As managers of EM local currency bond portfolios, we have seen the asset class become broader, deeper and more sophisticated, while never losing the country-level differentiation that makes it so compelling.
The launch of the J.P. Morgan GBI-EM benchmark in 2005-2006 came at a crucial moment - the Asian financial crisis was still fresh in everyone's memories. Our clients were sceptical, but also intrigued.
With the crisis having paved the way for flexible exchange rates and more sustainable policy frameworks, EM local was ready to be taken seriously.
An emerging asset class
More flexible exchange rates led to reserve accumulation, restoring credibility and strengthening financial institutions. The adoption of inflation targeting regimes deepened domestic capital markets. Governments increasingly borrowed in their own currencies rather than relying on hard currency funding, reducing vulnerabilities associated with foreign currency debt.
The resulting asset class offered something distinct: exposure not only to sovereign credit, but also to a diverse range of domestic and regional interest rate cycles, yield curve dynamics and currency adjustments. The "local" element moved from being an operational complication to an important source of opportunity. Today, the EM domestic debt market is worth some USD 46 trillion, compared with just USD 6 trillion for external debt, according to BIS.
But the biggest change in EM local over the past two decades has not been its growth in size. It has been the remarkable improvement in policy credibility across much of the emerging world.
A smaller credibility gap versus developed markets brings with it relative resilience, lower volatility and a more structurally sound asset class, with greater resilience to global shocks. Recent episodes of market turbulence are testament to this hard-earned credibility.
Policy credibility, EM vs DM
Source: Şebnem Kalemli-Özcan & Filiz Unsal, 2023. "Global Transmission of Fed Hikes: The Role of Policy Credibility and Balance Sheets". The measure of policy credibility is the monetary policy frameworks index (IAPOC, Unsal, Papageorgiou and Garbers (2022)). Data covering period 01.01.2007-31.12.2021.
Re-evaluating EM risk premia
While the GBI-EM benchmark opened the door to EM local currency bond investing, its existence is also a testament to how much the asset class has evolved.
Former benchmark members such as Hong Kong, Singapore and Korea are now considered developed markets, illustrating how rising incomes, stronger institutions and deeper financial markets can fundamentally change a country's “label”.
Other economies are making steady progress towards graduation. Czechia, Chile, Poland, Malaysia and Hungary have seen risk premia compress over the years. The boundary between emerging and developed markets is becoming increasingly blurred as countries develop and become more deeply embedded in global economic, regulatory and governance frameworks.
Even within markets that remain firmly in the EM universe, improvements in policy credibility can warrant a substantial reassessment of investment risk. Some of the most compelling opportunities arise when investors begin to recognise those improvements before they are fully reflected in market pricing.
South Africa offers a case in point. When I started my career, the country was viewed as the archetypal high-yielding emerging market. Investors were attracted by the carry, but there was always a lingering concern that inflation would overshoot the upper end of the target band and expose weaknesses in policy credibility. You could make money, but you were constantly looking over your shoulder for the next shock. The moment the external environment became more challenging, you got out of the trade, or even took short positions.
Over time, that picture has changed. The South African Reserve Bank’s shift from a target range to a single inflation target has sharpened its commitment to price stability and provided greater transparency around future policy decisions. Combined with improved fiscal discipline, this has helped anchor inflation expectations (see Fig. 2) and reduced the structural risk premium embedded in local yields. We increased our holdings well beyond benchmark weight around the adoption of the new inflation target in 2025, benefiting from that reassessment.
South Africa's journey is not yet complete, and there may be bumps ahead. But its trajectory tells a broader story about EM local currency bonds. Today, in markets such as South Africa, I spend far more time thinking about the economic cycle, fiscal policy and global duration than whether the next inflation print will discredit the entire policy regime.
South African CPI inflation expectations one year ahead, %
Source: Pictet Asset Management, LSEG Refinitiv. Data as of August 2026. Data covering period 01.03.2000-30.06.2026.
Compared with 20 years ago, emerging markets generally exhibit lower volatility, reduced dependence on external financing, smaller current account deficits and stronger sovereign balance sheets.
Compared with 20 years ago, emerging markets generally exhibit lower volatility, reduced dependence on external financing, smaller current account deficits and stronger sovereign balance sheets. We are no longer trading EM local currency bonds purely as opportunistic sources of yield. Increasingly, they are an asset class where institutional quality, policy credibility and central bank discipline sit at the heart of the investment case.
For us, this evolution has transformed EM local currency bonds from a specialist allocation into an asset class that deserves to be assessed alongside any other global asset on its risk-return merits, and which sits firmly on the efficient frontier between risk and return (see Fig. 3).
Forecast risk and return in USD, %
This efficient frontier uses the long-term (10-year) asset classes return forecasts published in the Pictet Asset Management's Secular Outlook 2026 as expected returns. The frontier uses historical realised volatility and historical correlations (historical data covering 01.09.2020-31.08.2026). Source: Pictet Asset Management, LSEG.
Active opportunities beyond benchmark weights
To fully benefit from the opportunities available in the asset class, investors need to take an active approach rather than being tied to a benchmark. That’s because benchmark weights primarily reflect market size. They cannot anticipate regime shifts, turning points in policy credibility or changes in the economic cycle. Yet it is often these moments of change that create the most compelling investment opportunities.
Few episodes better illustrate the importance of policy credibility than Turkey. During the 2021-2023 crisis increasingly unorthodox policies undermined confidence, making preservation of capital a more pressing consideration for us than the attractive yields on offer. We adopted a defensive stance, holding zero allocations to Turkey in our portfolios until we regained confidence in the policy regime. We re-engaged with a more constructive view in 2023, when the appointment of Finance Minister Mehmet Şimşek and a new economic team signalled a return to policy orthodoxy. Policy rates were raised sharply, inflation began to moderate and domestic investors delivered perhaps the ultimate vote of confidence: a gradual reversal of dollarisation and renewed confidence in the lira (see Fig. 4).
Turkey is re-establishing its policy anchors, a process that is not yet complete. The episode reinforces a lesson I have seen repeatedly throughout my career: policy credibility, while easy to lose, remains one of the most powerful drivers of economic and investment outcomes. As active investors, it is our job to distinguish between high yields that over-compensate for improving risks and those that merely reflect deteriorating fundamentals.
Dollarisation ratio (share of residents' FX deposits in residents' total deposits, %)
Source: Pictet Asset Management, LSEG Refinitiv. Data covering period 01.02.2022-31.08.2026.
The same principle extends beyond individual countries. Changes in global economic cycles and policy regimes also shape the broader interest rate and currency environment in which EM investors operate. Having a clear macroeconomic view to guide portfolio construction has always been key for returns.
During 2021-22, as inflation surged and global central banks embarked on the most aggressive tightening cycle in decades, we halved portfolio duration to reflect the changing global interest rate environment and reduce exposure to rising yields.
Currencies present a different challenge. As EM investors, we are acutely aware that policy uncertainty is rarely positive for exchange rates, even though the US dollar has historically been spared the same level of scrutiny. When President Donald Trump's Liberation Day tariffs were announced in 2025, we took the view that global trade would not simply stop. Rather, the resulting uncertainty would weigh on the US itself. With our valuation models showing the US dollar at historically expensive levels after more than a decade of dominance, we positioned for a cycle of weakness.
EM exports by type, % of total
Source: Pictet Asset Management, CEIC, LSEG. Data covering period 01.01.1990-30.04.2026.
The next chapter: EM local in a changing world
We have come a long way from the maverick days of early EM bond investing. The next chapter will bring new changes and opportunities. Based on our experience, we see four key themes that will shape EM bond markets and our investment ideas over the coming years:
- From convergence to influence: The first chapter of EM local currency bonds was largely a story of convergence: countries building domestic markets, strengthening policy frameworks and narrowing the gap with developed economies. The next decade may be defined less by catching up and more by shaping global outcomes, as EM economies become increasingly important drivers of growth, trade, inflation and capital flows. We see select opportunities in high-quality markets of North Asia, at the heart of the AI supply chain, and Central and Eastern Europe, where the convergence story continues.
- A more connected EM-to-EM world: Trade, investment and financing relationships are increasingly taking place within the EM universe (see Fig. 5). Regional supply chains and cross-border capital flows are being redrawn for a more multipolar economic structure, in which developing countries are less reliant on demand and financing from the developed world.
- The rise of the middle powers: Countries such as India, Indonesia, Brazil and South Africa are likely to play a more important role in a multipolar world. Their strategic value lies increasingly in flexibility: maintaining relationships across competing blocs while still pursuing their own economic and geopolitical interests.
- The new strategic investment cycle: AI, electrification, climate adaptation and higher defence spending are driving demand for power, semiconductors, data infrastructure, industrial metals and secure supply chains. The winners will be countries which offer not only the natural resources but also investment-friendly regimes, effective infrastructure and access to long-term capital. We believe Latin America is particularly well placed, combining attractive valuations and abundant metals and energy resources with a shift towards more investment-friendly policies that could unlock a new private capital spending cycle.
The next chapter is particularly exciting: EMs are no longer simply adapting to a global cycle, but increasingly helping to shape it. For active investors, that should create an even richer opportunity set — provided we remain disciplined in separating durable policy progress from temporary optimism.
