Why investors should consider emerging markets bonds in 2024 (2024)

Expert insight

February 22, 2024

Why investors should consider emerging markets bonds in 2024 (1)

Daniel Shaykevich

Principal, Senior Portfolio Manager, Manager Emerging Markets

Vanguard’s active fixed income team believes emerging markets (EM) bonds could outperform much of the rest of the fixed income market in 2024 because of the likelihood of declining global interest rates, the current yield premium over U.S. investment-grade bonds, and a longer duration profile than U.S. high yield.

Key highlights

  • The current environment is supportive of fixed income assets, in general, and EM bonds, in particular.
  • Owing to their unique return profile, EM bonds should stand to benefit if the Federal Reserve and other central banks cut interest rates, as expected.
  • Valuations on EM bonds look attractive relative to U.S. investment-grade and high-yield bonds. New issuance in January helped improve valuations.

Why it matters

Investors typically need to proactively allocate to EM bonds, since they are often a small part of core or core-plus strategies and typically not included in model portfolios.

Strong returns in 2023

EM bonds, as measured by the JPMorgan EMBI Global Diversified Index, returned 11.1% last year. A key driver of strong EM credit returns in 2023 was a supportive demand-and-supply dynamic. Investment-grade (IG) issuers outperformed their fiscal budgets in 2023, limiting their need to issue debt. High-yield (HY) issuers faced prohibitively high funding costs composed of high Treasury yields plus wide spreads and turned instead to official creditors for funding.

As EM IG spreads tightened due to the lack of supply throughout 2023, we used the opportunity to rotate out of EM IG and into EM HY issuers, where our team identified compelling valuations coupled with improving fundamentals. Additionally, we sought exposure in EM local currency bonds, capitalizing on falling inflation and high real yields in EM economies. In our multi-sector funds, we substituted out EM IG for U.S. credit where valuations were more attractive.

Expecting another strong year in 2024

Coming into this year, we were defensively positioned in EM IG, expecting more normal totals of debt supply to push spreads wider. Following large front-loaded new issue supply, EM IG spreads are now at attractive levels versus U.S. credit, setting up EM debt for outperformance. Our 2024 macroeconomic base case features slowing inflation and growth cushioned by Fed rate cuts. This environment is supportive of fixed income assets, in general, and credit assets, in particular.

In addition to attractive valuations, the EM asset class benefits from a unique combination of wide spreads and long duration, something that neither U.S. IG nor U.S. HY can offer. This leaves EM debt uniquely poised to benefit from a rally in rates as central banks cut, and from supportive risk appetite as growth normalizes. With historically expensive valuations in U.S. corporate bonds and strong investor demand for fixed income assets, EM debt stands to benefit. Increasing demand is likely to overwhelm supply in the coming months, helping drive outperformance in EM debt.

EM bonds offer compelling valuations

Why investors should consider emerging markets bonds in 2024 (2)

Note: Emerging markets credit represented by JPMorgan EMBI Global Diversified Index, U.S. investment grade represented by Bloomberg U.S. Corporate Bond Index, and U.S. high yield represented by Bloomberg Corporate High Yield Index.

Sources: Bloomberg and JPMorgan, as of January 30, 2024.

EM IG and HY spreads are near their most attractive levels versus U.S. credit in two years

Sources: Bloomberg and JPMorgan, as of January 30, 2024.

EM IG issuance is particularly front-loaded in 2024 with 47% of expected issuance completed

Why investors should consider emerging markets bonds in 2024 (4)

Note: Full-year 2024 emerging markets investment-grade issuance is a forecast.

Source: Bloomberg, as of January 30, 2024.

How to access

Three Vanguard products offer significant exposure to emerging markets bonds:

Active

Vanguard Emerging Markets Bond Fund (VEGBX)

Vanguard Multi-Sector Income Bond Fund (VMSAX)

Index

Vanguard Emerging Markets Government Bond ETF (VWOB)

Related links:
  • Active fixed income and our ownership structure (article, issued February 2024)
  • Vanguard active fixed income perspectives Q1 2024: Yield mountain(article, issued February 2024)

Notes:

For more information about Vanguard funds or Vanguard ETFs, visit advisors.vanguard.com or call 800-997-2798 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. All investing is subject to risk, including possible loss of principal. Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.

Investments in bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

Bonds of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

High-yield bonds generally have medium- and lower-range credit-quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit-quality ratings.

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Why investors should consider emerging markets bonds in 2024 (5)

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Why investors should consider emerging markets bonds in 2024 (2024)

FAQs

Why investors should consider emerging markets bonds in 2024? ›

Among the opportunities in the fixed income markets in 2024, local-currency EM bonds may be one to consider for investors with a higher risk tolerance. The relatively high yields and likelihood of rate cuts by global central banks have created a tactical investment opportunity.

Why invest in emerging markets in 2024? ›

Emerging markets' growth is expected to remain steady in 2024 at around 4%. Recently released emerging economies' manufacturing and services Purchasing Managers Index surveys, which focus on current and near-term economic expectations, mostly point to economic expansion in the coming months.

What is the outlook for emerging market bonds in 2024? ›

Vanguard's active fixed income team believes emerging markets (EM) bonds could outperform much of the rest of the fixed income market in 2024 because of the likelihood of declining global interest rates, the current yield premium over U.S. investment-grade bonds, and a longer duration profile than U.S. high yield.

Why do investors Favour emerging markets? ›

The pros of investing in emerging markets

Potential for high returns: The average returns for emerging markets can vary. Global asset management firm Alliance Bernstein says the MSCI EM index delivered annualised returns of 15.9% between 2001 and 2010.

Are high yield bonds a good investment in 2024? ›

High-yield bonds have fared better amid a generally 'risk-on' market. However, it is possible to see these roles reversing in the remainder of 2024, as default rates rise, hitting high yield, and interest rates start to come down, favouring investment grade.

Will emerging markets do well in 2024? ›

A third consecutive monthly acceleration in global output growth was supported by faster emerging market expansion while developed markets also returned to growth for the first time in six months.

Is it a good idea to invest in emerging markets? ›

When basic caution is exercised, the rewards of investing in an emerging market can outweigh the risks. Despite their volatility, the most growth and the highest-returning stocks are going to be found in the fastest-growing economies.

Is now a good time to buy emerging market bonds? ›

Among the opportunities in the fixed income markets in 2024, local-currency EM bonds may be one to consider for investors with a higher risk tolerance. The relatively high yields and likelihood of rate cuts by global central banks have created a tactical investment opportunity.

What percent of portfolio should be in emerging markets? ›

In short, a review of the three standard approaches to EM allocation suggest global equity investors should allocate somewhere in the range of 13% to 39% to EM. Source: FactSet, MSCI, MSIM calculations.

Are emerging market bonds high yield? ›

Emerging market bonds are debt instruments issued by developing countries. These bonds tend to over higher yields than Treasuries or corporate bonds in the U.S.

What is the best way to invest in emerging markets? ›

Investing in individual emerging markets stocks is difficult for the average investor, so mutual funds and ETFs are often the most effective way to do it. Look for funds with high assets under management.

What are the problems with investing in emerging markets? ›

Because emerging markets are viewed as being riskier, they have to issue bonds that pay higher interest rates. The increased debt burden further increases borrowing costs and strengthens the potential for bankruptcy. Still, this asset class has left much of its unstable past behind.

What is the outlook for emerging markets? ›

We remain positive on emerging market (EM) equities in 2024. Drivers for EM equities in the new year include the likelihood that US interest rates have peaked, a recovery in earnings growth, and the economic outlook in China, which appears to be past the worst.

How will high-yield bonds perform in 2024? ›

Junk-bond ETFs showed a slight uptick, suggesting potential outperformance in 2024, especially under a soft-landing scenario for the US economy, according to Michael Arone of State Street Global Advisors.

What is the safest bond to invest in? ›

Treasuries are generally considered"risk-free" since the federal government guarantees them and has never (yet) defaulted. These government bonds are often best for investors seeking a safe haven for their money, particularly during volatile market periods. They offer high liquidity due to an active secondary market.

What is the downside of high-yield bonds? ›

What are the risks? Compared to investment grade corporate and sovereign bonds, high yield bonds are more volatile with higher default risk among underlying issuers. In times of economic stress, defaults may spike, making the asset class more sensitive to the economic outlook than other sectors of the bond market.

What is the future of the stock market in 2024? ›

Falling interest rates and earnings growth could be a bullish combination for stocks. However, some analysts are concerned about bloated valuations in the technology sector, and the 2024 U.S. presidential election could create some major volatility in the market.

What will happen to the stock market in 2024? ›

Wall Street analysts ultimately expect S&P 500 companies to grow earnings by roughly 11% in 2024. And by the fourth quarter, growth is expected to have roughly evened out, with the top 10 stocks expected to see growth of 17.2% while the other 490 companies see growth of 17.8%, according to FactSet data.

What are the best stocks to invest in 2024? ›

2024's 10 Best-Performing Stocks
Stock2024 return through March 31
Janux Therapeutics Inc. (JANX)250.9%
Trump Media & Technology Group Corp. (DJT)254.1%
Super Micro Computer Inc. (SMCI)255.3%
Viking Therapeutics Inc. (VKTX)340.6%
6 more rows
Apr 1, 2024

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