Talk Your Book: The Case for Investing in Emerging Market Bonds

For decades, the conventional wisdom was simple: emerging market bonds are riskier than developed market bonds. The volatility is higher, the currencies are unstable, and the politics are unpredictable. That story is now upside down. Over the past ten years, the volatility of emerging market bonds and currencies has fallen below that of developed markets like the U.S., UK, and Japan. At the same time, the carry—the yield you earn if nothing changes—is higher in EM bonds than in Treasuries or the aggregate bond index. Lower volatility plus higher carry is a combination that most investors have not yet absorbed.

What Changed: The Absence of Fiscal Dominance

The core reason for this shift, according to Eric Fine, portfolio manager of the VanEck Emerging Markets Bond ETF (ticker EMBX), is the absence of fiscal dominance in emerging markets. Fiscal dominance is the dynamic that occurs when a government has too much debt: the central bank is pressured to keep real interest rates low to service that debt, which ultimately leads to higher inflation. Fine says he has seen this movie play out roughly 80 times in emerging markets. The difference now is that most countries in his benchmark have learned the lesson. Government debt levels in many EM countries are relatively low, and their central banks are fiercely independent and focused solely on inflation. This is not just a fisca