However, even if these risks materialise, differentiation across EM can allow active investment management to weather broad macro risks through credit selection within select countries, regions and sectors.
EM economies are certainly vulnerable to a global recession.
However, within a shallow growth deceleration, the higher quality EM credits with high carry may benefit, as EM credit spreads may widen less than the compression in treasury yields.
EM debt faces a potential headwind of heightened political uncertainty related to US foreign policy.
There could potentially be an increase of volatility leading up to the US presidential election as candidates campaign on a return to protectionist policies.
However, in the recent past, divisive campaign rhetoric toward foreign countries has been more a starting point for bilateral negotiations.
Additionally, some countries stand to benefit from these policy shifts, in particular from near-shoring and friend-shoring as the US and EU move supply chains away from China.
While geopolitical risks are hard to quantify and trade, certain regions are better able to weather these risks.
Latin America remains more insulated from conflicts within the Middle East, Europe and Asia. Indeed, EM commodity-linked economies, which tend to be low-cost producers, may benefit from higher commodity prices.
The asset class is a secular improving story that offers an immense opportunity to invest across different regions, countries, industries, currencies, and ratings.
Opportunities lie within the EM countries that have institutional strengths, supportive growth outlooks and increasing linkages to DMs, such as those within Latin America, with favourable outlooks in both Mexico and Brazil.
Latin America remains more insulated from geopolitical risks and stands to benefit from a near-shoring trend that is already beginning to boost foreign investment, particularly in the case of Mexico.
EM corporates have evolved into an asset class of its own, with a market capitalisation that far exceeds that of EM sovereigns and US high-yield bond market.
The fundamentals for EM corporates have remained quite resilient despite the macro uncertainties, thanks to overall conservative financial policies. Moreover, EM corporates offer an attractive spread pick-up relative to EM sovereigns and comparably rated DM credits.
Within EM corporates, we tend to favour the sectors that are strategic, for example those sectors deemed necessary for the smooth functioning of their domicile countries.
These sectors include banking, utilities, natural resources and transportation.
All said, the macro environment is largely favourable for EM debt with opportunities to invest in EM countries tyhat have a strong domestic story and in EM corporate credits, which have strong to improving credit fundamentals and a dedicated local investor base.
