Local currency emerging market debt: why its structure favours active management
23 OCT, 2026
Local currency emerging market debt has become one of the most diverse opportunity sets in global fixed income. Jeremy Cunningham, Fixed Income Investment Director at Capital Group, and Rob Drijkoninge, Senior Portfolio Manager, Head of Fixed Income Europe and Global Co-Head of Emerging Markets Debt at Neuberger, explain why the asset class rewards selectivity – and where they currently see value.
Issuance has increased, liquidity has deepened, yield curves have developed and the investor base has broadened, among both domestic and international investors. For many emerging economies, a functioning local bond market and credible monetary policy are now signs of economic development rather than aspirations, says Cunningham.
For Capital Group, the debate has moved on. 'For many investors, the question is no longer whether local currency EMD deserves an allocation, but how best to gain exposure to it. A passive or smart beta approach offers a low-cost entry point, but it also embeds a series of decisions that many investors may not fully appreciate. In our view, the structural characteristics of this asset class – specifically its breadth, heterogeneity and multiple sources of return – create conditions in which specialist active management is particularly well positioned to add value.
A market far larger than its benchmark
According to Cunningham, the main benchmark covers less than 17% of the market.
The scale of the market highlights the size of the opportunity. The widely followed JPMorgan GBI-EM Global Diversified index represents around USD 2.8 trillion, compared with approximately USD 16.6 trillion of tradable local currency government debt. From the outset, therefore, there is a significant opportunity set outside the standard benchmark.
Jeremy Cunningham, Fixed Income Investment Director at Capital Group
The universe is also far from uniform, which is why emerging market debt should not be generalised. The most important characteristic of this asset class is that it is not homogeneous. Dispersion is not a secondary feature, but the foundation of the case for active management. The greater the differences between countries, the greater the potential for a manager who analyses them in depth to distinguish between them and allocate accordingly, he says.
Benchmarks reflect eligibility, not opportunity
Cunningham stresses that an index is always a simplification. 'A benchmark is a useful tool: it provides a reference point for risk, allows managers to be compared and facilitates their selection. For precisely these reasons, we take benchmarks into account. But the choices embedded in that simplification have real consequences. Index providers must prioritise liquidity, transparency and operational simplicity. The result is an index that reflects what qualifies for inclusion, and not the full set of investable assets.
Index construction also shapes country weights. The starting point for most local currency EMD indices is the volume of sovereign debt outstanding, so exposure tends to tilt towards the most indebted issuers. The widely used JPMorgan GBI-EM Global Diversified index mitigates this effect through a 10% cap per country, but that cap is itself an active decision. The consequences are not neutral. The methodology alters regional and country exposures in ways the investor may not have anticipated. In other words, a passive allocation is not as passive as it seems.
The takeaway for investors is subtle but important. Choosing a benchmark, and opting to replicate it, is in itself an active decision about future beta. An active manager, by contrast, can use the index as a reference rather than a constraint, and access the broader opportunity set that exists beyond it, including off-index securities, where inefficiencies tend to be greater, Cunningham adds.
Multiple, independent return drivers
For Capital Group, those drivers are genuinely independent of one another. Local currency EMD is unusual within fixed income in that it offers several distinct return drivers. This matters because it multiplies the ways in which an active manager can express an investment view. Because local currency returns are driven mainly by domestic interest rates, inflation dynamics and country-specific policies, rather than by global credit cycles, the asset class has historically shown only a moderate correlation with US high yield, of approximately 0.5 to 0.6.
On currencies, Cunningham is clear: They can contribute significantly, positively or negatively, to total return and, over extended periods, emerging market currencies have tended to depreciate against those of developed markets. However, valuations move in cycles, and periods of currency weakness can create the conditions for future appreciation. Capturing that potential requires active selection, rather than passive exposure to the basket as a whole.
Index mechanics create exploitable inefficiencies
The rules that determine index inclusion are themselves a source of opportunity. Index composition changes on a set schedule; fundamentals do not. This mismatch forces passive capital to move mechanically, creating divergences between price and fair value that an active manager can anticipate, Cunningham explains. 'What matters is the mechanism, not any single episode. Forced, calendar-driven flows are predictable in direction, if not always in magnitude, and a manager who positions in advance is rewarded for an ability to anticipate that the benchmark itself cannot exercise.'
Anticipating opportunities, however, is only half the job. A common misconception is that the return potential of local currency EMD is simply about taking more risk. In our experience, it is the opposite discipline that distinguishes strong long-term results: the task is not to maximise risk, but to determine which risks are worth taking, which should be hedged and which should be avoided altogether. Because duration risk and currency risk can be separated and managed independently, an active manager has real control over a portfolio's risk profile as volatility regimes change.
Capital Group has organised its approach around these requirements. Emerging market debt is covered by specialist sovereign and corporate analysts, macroeconomists and a currency strategist, rather than generalists, so that dispersion between countries is analysed at the level at which it actually occurs,' Cunningham explains. A dedicated team assesses market mechanics and counterparty access in more than 75 markets – 'something that often determines whether an off-index opportunity is genuinely investable or simply attractive on paper.
Why local currency looks more attractive than hard currency
Drijkoninge believes EM debt is well placed to withstand developed market turbulence. Although correlations indicate that, in trend terms, emerging markets and developed markets will be linked, the limited fiscal financing and balance of payments risks in emerging markets suggest they remain well positioned to weather any storm. So far, both local and hard currency debt have held up well against the current volatility stemming from developed market policies.
While valuations remain tight, especially in hard currency markets, yields in both local and hard currency markets remain attractive compared with developed markets. Furthermore, local currency EM debt offers higher real yields and gives investors the opportunity to diversify their fixed income allocations away from the US, including the US dollar.
Rob Drijkoninge, Senior Portfolio Manager, Head of Fixed Income Europe and Global Co-Head of Emerging Markets Debt at Neuberger
Neuberger sees opportunities across the asset class but has a clear preference. We see multiple opportunities in both hard and local currency EM debt markets. EM fundamentals have continued on an improving trajectory, as reflected in net credit rating upgrades across countries and among EM corporates. Hard currency sovereign and corporate markets now offer yields above 7%, which has historically been an attractive entry point for investors over the following 12 months. However, credit risk premia have tightened quite significantly since 2023. We therefore see more attractive opportunities in local currency markets, where nominal and real yields are at 15-year highs relative to developed markets.
The view echoes the case for emerging debt as a real opportunity after this year's sell-off.
Lower volatility through short-duration EMD
For investors seeking a smoother ride in turbulent times, Drijkoninge points to short-duration EMD. A lower-volatility approach to EM fixed income is possible through short-duration emerging markets debt. The short-duration hard currency EMD universe has less than half the volatility of the broader hard currency EMD universe, as measured by the JPM EMBI GD index since 2003. While it limits participation in rallies to some extent, it offers attractive downside protection, resulting in a very interesting risk-adjusted return. The yield is also competitive with the broader market, generating a solid income stream for investors.
Conclusion
Cunningham sums up the case: 'The structural characteristics of local currency EMD – its dispersion, the simplifications embedded in its benchmarks, its multiple sources of return, and the inefficiencies and risks arising from its own mechanics – are precisely the conditions in which we believe specialist active management can add the most value.'
Neuberger adds a valuation argument: with hard currency spreads compressed, local markets offer the more compelling mix of real yield and diversification away from the US dollar, while short-duration strategies provide a lower-volatility route into the asset class. For fund selectors reviewing where to invest in fixed income in the second half of 2026, country selection and risk discipline remain decisive.
Disclaimer: This article is for informational purposes only and does not constitute financial, tax or legal advice, nor an offer to buy or sell financial instruments. The opinions expressed reflect the views of Capital Group and Neuberger and are subject to change without notice. Past performance is not a guarantee of future results. Emerging market debt involves specific risks, including currency volatility, liquidity, sovereign and corporate credit risk.
