Emerging market (EM) debt seems to be attracting renewed interest as concerns over US fiscal policy, persistent inflation and geopolitical uncertainty spur investors to diversify beyond traditional developed markets.

According to Barings, a blended approach – which combines sovereign, corporate and local currency debt – could help portfolios capture opportunities across an asset class that remains widely misunderstood.

In a recent report, Cem Karacadag, head of Global Sovereign Debt & Currencies Group at the firm, and Andrew Plunkett, client portfolio manager in the same team, say EM debt offers greater breadth, credit quality and diversification potential than commonly perceived.

Excluding China and Russia, emerging and developing economies account for approximately 23% of global GDP, while the EM debt universe spans more than 90 countries and 1,500 corporate issuers, the report highlighted.

Yet misconceptions about credit quality continue to influence investor allocations.

Better credit quality than expected

One of the biggest misconceptions is that EM debt is predominantly speculative grade.

According to JP Morgan data cited by Barings, 60.1% of EM corporate debt and 47.2% of sovereign hard currency debt were investment grade (IG) at the end of 2025. Around 80% of the local currency debt market also carries IG ratings.

Default rates similarly challenge perceptions of widespread credit weakness. Over the past decade, EM sovereign debt recorded an average annual default rate of 2.7%, while EM high yield corporate defaults averaged 5.2%, compared with 2% for US high yield bonds.

Although the EM corporate segment poses a higher risk, Barings argues that investors are compensated through higher yields and greater diversification opportunities.

The firm also highlights the distinct return drivers across the asset class. Hard currency sovereign and corporate debt performance depends largely on credit fundamentals and spread movements, while local currency bonds are influenced by domestic interest rate cycles and currency valuations.

This creates opportunities for investors to benefit from different market conditions rather than relying on a single source of returns.

Benefitting from flexibility

Barings also believes the investment case has strengthened following several years of economic and geopolitical shocks, during which EM debt demonstrated greater resilience than many investors anticipated.

A potential reversal of the US dollar’s prolonged appreciation against EM currencies could provide another tailwind, particularly for local currency bonds.

The dollar’s decline since 2025 was interrupted by the Middle East conflict, but Barings sees reasons for weakness to resume once the conflict is resolved.

Against this backdrop, the firm favours an actively managed, blended approach that can shift exposures between sovereign, corporate and local currency opportunities as valuations and fundamentals evolve.

“One key benefit of a blended strategy is that it enables investors to delegate tactical investment decisions to managers with expertise across the full EM debt spectrum,” the report stated.

Rather than relying on broad macro calls, Barings advocates bottom-up country and credit selection to identify improving fundamentals and attractive relative valuations.

However, currency volatility, geopolitical developments and issuer-specific credit deterioration remain important risks, reinforcing the case for selective active management.