Emerging market debt: Frontiers, fundamentals, and falling inflation

Stronger fundamentals and cooling inflation fueled a breakout year for emerging market fixed income – a topic Paul Mohr and Anthony Simmond explore as they discuss key drivers and the opportunities ahead. 

Transcript

Paul Mohr
Hello, my name is Paul Moore, Senior Director with Aberdeen, and you're listening to the Emerging Market Fixed Income Quarterly Podcast, the show that looks at what happened in the recent quarter and provides our outlook for the asset class. Today I'm joined by my colleague, Anthony Simmond, Investment Director with our Emerging Market Fixed Income team. Welcome to the podcast, Anthony. It's great to have you on.

Anthony Simmond
Yeah, thanks, Paul. Good to be here.

Paul Mohr
Before we jump into some of the current events and outlook for the year, let's start as we always do by taking a look back. And let's start with a brief rundown of performance for 2025, Anthony, across the different sectors of the asset class, hard currency sovereigns, corporates, local currency bonds, et cetera.

Anthony Simmond
Yeah, sure. I mean, it was a great year in the end for the asset class. And I'm not sure people would have been saying that after so‑called Liberation Day back in April. But hard currency sovereigns were up over 14% on the year. Spreads against U.S. Treasuries were tighter by over 70 basis points and really driven by a strong risk‑on attitude. So high yield particularly, and within high yield frontier did very well. So frontier market bonds are up something like 20% compared to investment grade, which returned positive 10%. There’s a good performance from distressed debt. And this is actually something we’ve seen over the past two or three years.

This time in 2025, it was Venezuela that topped the charts, returning nearly 100%, nearly doubling in value. A lot of that coming in the fourth quarter of the year as the U.S. really tried to put pressure on the Venezuelan government to start tuning their policies. I'm sure we'll get into a bit more detail on that later. Lebanon also performing well, up nearly 80%. You know, both of those countries are in default, but investors are anticipating an improvement in the underlying environment that will allow restructuring to take place—maybe not this year, but maybe in 2027, 2028. And then lastly, Bolivia, third best performer in our universe, up nearly 60%, driven by a positive election result. And they avoided default. It seems like they're doing the right thing now.

On the negative side within emerging market hard currency debt was Senegal. It was the only country to experience negative returns. Senegal lost about 20% of its value. There are some fears that there may be a default in Senegal in 2026, and that's one of the reasons why it performed so poorly. Interestingly, China also underperformed in the risk‑on environment. It did return positive 7%, but tends to be a country that is overlooked in an environment where the higher‑beta names are in demand.

In corporates, corporates underperformed within EM. It was up about 8.5–9%. Spreads tighter by three basis points. Again, high yield marginally outperforming investment grade. It’s a low‑duration asset class. It is higher rated, better quality. So again, you know, I'm repeating myself a little bit, but in this kind of risk‑on environment, corporates do tend to underperform. They don't have the kind of distressed debt that the hard‑currency sovereign universe does.

And then actually local market for the first time in a long time was the best performer, up nearly 19% in U.S. dollar terms. Yields were tighter by 52 basis points to end the year at 5.9% total yield. Had strong performance from South Africa across both rates and currencies, up nearly 40%, but also Mexico and Brazil up nearly 35% as well. Despite some geopolitical issues with the U.S., that didn’t really matter so much. Monetary policy and a weak dollar environment really benefited these countries. On the other side, Asia underperformed, particularly India and China, but no country had a negative total return over the course of the year. I'll stop there. I'm happy to get some more questions.

Paul Mohr
Yeah, I think, I mean, you mentioned high yield and frontier in particular doing really well on an absolute and relative basis and really the entire EM sector performing well overall. You've given that strong performance. So did we see really any meaningful inflows into EMD? And if so, in what particular areas?

Anthony Simmond
Yeah, we did see inflows returning to the asset class for the first time in something like three years. 2021 was the last year we had meaningful inflows. Last year, 2025, we had $17 billion going into hard‑currency funds and about $16 billion going into local‑market funds. So yeah, a good result. Total EMD assets, though, are still about $100 billion lower than the peak that we saw at the end of 2021. So a little bit of a while to go before we hit kind of the peak AUM within the asset class. But there's definitely a lot of interest from investors. We're seeing increased kind of RFP activity, increased marketing opportunities, and definitely, you know, that's coming through into the market itself with some flows.

Paul Mohr
Yeah, and it sounds like the story is fairly positive from both a flow perspective, performance perspective. The macro backdrop seems to be supportive as well. Given the steady global growth and the Fed is expected to continue cutting rates, how does this impact EM? Is it positive, negative, assuming it's positive for the year?

Anthony Simmond
Yeah, I mean, if the Fed does continue to cut rates, that is a positive. When you look back on history, emerging market debt has always benefited from loose Federal Reserve policy. I mean, what we're seeing actually in the first few weeks of the year is maybe the market kind of pushing back a little bit on that more dovish Fed outlook. That's definitely a risk that we're looking at the moment.

The other thing to be mindful of, I think, is oil prices. At least in the short term, I think what's going on in Venezuela doesn't really affect oil, but over the medium to long term, having those additional barrels of oil enter the market, which is already pretty high in terms of supply, could be something to watch for. And emerging markets have always had a correlation with commodity prices and particularly oil, even though we are somewhat balanced between commodity exporters and importers. I still think that the asset class is seen as a little bit of a play on commodity prices. It's something to be wary of.

But generally, fundamentals within EM are very strong. We're seeing that in terms of credit‑rating performance. So over the last year or two, it's the first time in maybe a decade that we’ve had more credit‑rating upgrade stories in sovereign space compared to downgrades. And actually, I think that's going to continue. Most of the countries on negative outlook in terms of their credit rating are kind of investment grade, maybe on the triple‑B boundary. And it takes a little bit longer for those countries for the rating agencies to make a decision about those countries. Whereas on the upgrade list, we're looking at the recently restructured names that might have a triple‑C, or we’re also looking at some countries in the double‑B sector that are looking to move up into investment grade. So I think that actually it's going to be those countries—i.e., those moving to the triple‑B from high yield or moving from a kind of restructuring state in the triple‑C bucket into the B bucket—where we'll see a lot of movement in 2026.

Paul Mohr
Now, you mentioned Venezuela. It's certainly something that’s been in the market in the news cycle quite a bit recently with the recent events and President Maduro being removed from power and now set to stand trial here in the U.S. I want to get back to something. You mentioned that they're one of the countries that are currently in default and looking to go through a restructuring process. What's the impact of the current events here on that restructuring process for Venezuela? What does the path forward look like for them?

Anthony Simmond
Yeah, I mean, the bonds after the event on, I guess it’s a week on Saturday, caused a kind of 30% rally in the bonds in Venezuela. We're talking about bonds which have been priced kind of in the high 20s, maybe low 30s, and now priced in the low 30s, high 40s. So very significant. Removing Maduro was definitely seen by investors as a necessary first step before restructuring process can take place. But we're still a long way from any deal.

The U.S. government still doesn't recognize a Venezuelan government. That's very important. And it will be important in order to get multilateral organizations into the country. I'm talking about the IMF, the World Bank, who can do a proper economic assessment on the ground. And there are also some economic sanctions on Venezuela that need to be removed, specifically sanctions that prohibit the country from issuing new debt, like debt on the primary markets. And whenever there's a restructuring in sovereign universe, there's always a new bond or new instruments that come out of it. So without removing those sanctions, you know, we really cannot get anywhere close to a deal.

You know, what the market's also positive about is potentially the renewal of the oil industry, putting new investment in order to boost both production and export revenue. Again, it's going to be a slow process. It could take a decade or so before we get back to the levels seen—the highs seen—10, 15 years ago. But this is what the market is looking at the moment.

Paul Mohr
Yeah, I mean, it's certainly a fluid situation as we go through this here. Kind of a follow‑up to that though: are there any consequences for the broader Latin American region as a result of this? I mean, there are trade partners like Colombia and such that they work with. What's the kind of knock‑on effect of the Venezuela events?

Anthony Simmond
Yeah, good question. I mean, we've already seen the U.S. being quite forward in terms of intervening in other countries' politics, particularly in Latin America. We've seen it in Argentina. We've seen it in Honduras. And both of those elections went in the way of the pro‑Trump candidate. In Brazil, it didn't work so well.

I think in Colombia, there’s been a lot of barbs between the two leaders—Petro in Colombia and obviously Trump. But there are elections coming up in Colombia this year and President Petro is not allowed to stand for re‑election. So we are going to have a different candidate there. So we expect Trump to wait until the election result or try to influence the election via his tweets, via his policies, rather than anything militarily. But yeah, this is definitely something that we are watching very, very closely.

Paul Mohr
Switching gears then, kind of away from Latin America over to the African continent. And you mentioned Senegal by name earlier as a country that perhaps is at risk for default later in the year. Are there, in addition to Senegal—perhaps maybe dive into that a little bit deeper—but also, are there any other countries that we're keeping an eye on that are maybe susceptible to a credit event during the year?

Anthony Simmond
Yeah, Senegal is an interesting one. It's another country with a kind of hidden‑debt scandal. We had it in Mozambique five or six years ago. We're now having it in Senegal. Debt‑to‑GDP is over about 120%, 130%. And it really is a little bit touch‑and‑go on whether they'll be able to avoid a credit event. I think it's a question of when rather than whether it will happen or not.

They have a payment coming up, a coupon payment in March and maybe a small amortization payment in March. We kind of expect that to be paid. But after that, we think it's going to be a little bit tricky. They're searching at the moment, or they're in negotiation at the moment, for an IMF program. And that has taken much longer than anyone expected. And it’s maybe because there are disagreements really on the economic framework and economic forecasts for the next five to ten years.

So they're the only country, as I mentioned earlier, that had a negative return in 2025. There's no real other country, we think, that is close to a restructuring event at this point. In fact, it's going the other way. We actually had an agreement last week with Ethiopia and its creditors around its restructuring terms. As I mentioned also earlier, Bolivia avoided a restructuring. It feels like Maldives as well will avoid a restructuring. So we're really out of the woods, I should say. Post‑COVID, when we had a number of distressed opportunities in EM fixed income, that has really gone away now. So I think we're in a—as I said—the fundamentals of the asset class are looking as strong as it's ever been. I don't expect that to change anytime soon.

Paul Mohr
So with those strong fundamentals in mind, the positive outlook for the asset class, supportive policy from the U.S. and abroad—what are some of the areas that are providing some value opportunities for investors now? Maybe some overlooked areas? Areas that you and the team are maybe talking about?

Anthony Simmond
Yeah, I mean, we remain very bullish on our frontier markets, particularly local‑currency frontier markets. It’s an area that we’ve been rotating into over the past 6 to 12 months. The reason for that is that a number of countries had these so‑called maxi‑devals—so they devalued their currency very substantially back in 2023, 2024. So we've got cheap currencies now against the U.S. dollar and inflation has collapsed. You're also getting rate cuts, interest‑rate cuts, which are giving you a capital appreciation on your position as well.

Most emerging‑market countries, you know, it's not like the West. It’s very simple monetary policy. They cut rates when inflation comes down; they hike rates when the opposite. They don't have quantitative easing and Operation Twist and things like that. So it's very much simpler to understand. You don't have the number of different actors as well who are influencing these bond markets. So for us, that's a very interesting place to be.

You know, we continue to still like EM paper—particularly kind of better‑quality high yield, particularly the double‑B segment—where you're getting fundamentals which, if you were in a European or U.S. company, would be strong investment grade, but sometimes at the so‑called sovereign credit‑rating ceiling. So because the sovereign is rated X, the company can't be rated any higher. And it means that you're getting paid very well for the element of risk that you're getting.

So yeah, it remains kind of frontier markets, but also, you know, kind of lower‑risk corporate names as well that we are looking into.

Paul Mohr
Well, Anthony, this has been great. I really want to thank you for your time. This feels like a kind of a good place to wrap up the podcast episode for this week. So, thank you very much for joining us today. We really appreciate it.

Anthony Simmond
Thanks, Paul. Appreciate talking to you.

Paul Mohr
And thank you to everyone who took the time to listen in today. If you enjoyed the podcast conversation, please download our other podcasts from our website or wherever you normally get your podcasts from.