LGPS funds are showing a growing interest in fixed income. Room151 speaks to Amundi emerging market debt specialists Serena Galestian: Co-Head of EM Investment Specialists and Business Development, and Priyank Shah: Senior Investment Specialist, Emerging Markets Debt alongside Mark Davies, head of public markets at LGPS Central, which is invested in Amundi’s EMD fund, on the outlook for the asset class.
What is the case for including greater allocations to emerging market debt (EMD)?
Serena Galestian: EMD offers three tangible advantages to LGPS investors: access to stronger underlying growth, a meaningful yield pick‑up over most developed‑market fixed income, and the potential for attractive risk‑adjusted returns.
Institutional investors remain under allocated to EMD (less than 5% of their allocations), relative to its share of global growth (more than 50%) and market size (around 30% of the global fixed‑income debt stock). This mismatch creates a structural opportunity, as many EM economies exhibit healthier public‑debt ratios and higher real interest rates than several developed peers. A weaker US dollar and a global rate‑cutting cycle also strengthen the fundamental backdrop and support investors’ search for yield.
Mark, what role does EMD play in LGPS Central’s fixed income portfolio?
Mark Davies: EMD plays an important role in our asset allocation, and we expect it to become an increasingly significant component of pension portfolios. When comparing current allocations to EMD with the share of global GDP represented by emerging market economies, it is evident that the asset class remains materially underallocated.
EMD is a broad universe with diverse risk characteristics, yet, in general, emerging market governments are less indebted than their developed market counterparts. Both local and hard currency indices offer a meaningful yield premium for exposure to a less indebted and more diversified group of sovereign issuers.
Historically, EMD has often featured in multi-asset credit strategies, how is this evolving?
Serena Galestian: EMD is only slowly transitioning from being an opportunistic satellite allocation within multi-asset credit portfolios to a more strategic role. In our view, the asset class should now be considered a core allocation, supported by growth convergence with developed markets and the diversification benefits it provides. It also broadens an investor’s opportunity set, giving access to issuers in more than 70 countries.
The asset class offers greater certainty and predictability of cash flows than previously, with over 50% of hard‑currency indices rated investment‑grade and average historical default rates in the high‑yield segment of around 3–4%. Over the last three years the hard‑currency sovereign default rate has averaged only 0.7% on the back of rating upgrades, and current yields more than compensate for these risks.
How will US trade wars impact the outlook for EMD?
Serena Galestian: With various trade, economic and technology transitions underway, the coming decade is likely to be shaped by a shift towards a more multipolar world. These cross‑currents have created opportunities this year, evidenced by diversification efforts from governments, central banks and investors alongside a weaker US dollar, stronger gold prices and shifting correlations across traditional asset classes.
EMD stands to benefit as more tactical and multilateral agreements develop, ensuring trade and investment flows continue. These alternative trade alliances can provide an effective release valve for trade‑related pressures as supply chains are re‑routed and concentrated dependencies are reduced. Several emerging economies are already becoming beneficiaries of this reconfiguration, as multinational companies diversify production and lessen single‑country reliance.
How can EMD act as a portfolio diversifier in relation to developed market debt?
Priyank Shah: As EMD offers exposure to countries with distinct economic cycles and credit‑rating trajectories, the asset class exhibits lower correlations with traditional fixed income.
Long‑term correlations with US Treasuries are low and, in some cases, negative. Although correlations with US high yield are higher, the diversity across EMs, in our view, allows greater opportunity to add value beyond mere security selection. Long‑term risk‑adjusted returns of EM debt versus other asset classes are higher than those of US and/or global government bonds for similar levels of volatility.
How can LGPS investors whose liabilities are linked to the pound manage currency risks?
Priyank Shah: Hard‑currency EM debt carries no EM FX risk because bonds are denominated in USD or EUR; these exposures can be hedged back to GBP in full or in part.
A key consideration for local‑currency debt is how to treat the underlying FX exposure. FX can be fully hedged, partially hedged or left unhedged. Although hedging costs have declined in recent years, they can still be material, so it is important to assess how these costs will affect the investment’s return profile.
When investing in local- currency debt, we view local rates and currencies as independent investment decisions; currency exposures are not just a consequence of unhedged bond positions. Our directional view on a currency may be expressed as a long or short position relative to the underlying portfolio currency.
How are you managing ESG risks in your portfolio?
Priyank Shah: ESG considerations are fully integrated into our investment process. Our Responsible Investing team rates over 90% of EM hard‑currency issuers using a proprietary framework, and these scores feed directly into our sovereign and corporate research. We also engage with issuers to promote transparency and ESG improvement.
At the portfolio‑construction level, we exclude the lowest‑rated issuers across our EMD portfolios, aim to achieve a stronger ESG profile relative to the investment universe, and actively commit to minimum levels of sustainable bonds while using labelled and sustainability‑linked bonds where appropriate.
This process is supported by our extensive experience in Responsible Investing in emerging markets and underpinned by our dedicated ESG resources and collaboration with global institutions such as the IFC. Our long-standing partnership with the IFC since 2018 has been instrumental in supporting the development of the green, social and sustainable EM bond market. Under IFC’s Technical Assistance Facility, Amundi and IFC have trained 360 financial institutions, resulting in over 147 Green, Social, Sustainability and Sustainability-Linked bond (GSSS bonds) issues for a total face value of USD 18.5 billion since inception of the program in 2019.
Mark, what is your outlook for the asset class going forward?
We hold a constructive outlook for the asset class, driven primarily by improved reputational credit, favourable demographics and the potential for rapid technological convergence.
First, during the global financial crisis and subsequent periods of market stress, we observed an increasingly orthodox policy response from emerging market central banks and finance ministries. In contrast, much of the heterodox policy, including quantitative easing, has been concentrated in developed economies. This divergence has strengthened the reputational standing of EM issuers, suggesting that required yield premia should gradually decline. We are already seeing indications of this, with several Asian sovereigns issuing debt at yields below those of US Treasuries.
Second, emerging markets generally benefit from younger populations and more favourable dependency ratios than developed markets. A larger share of the population is of working age, with substantial cohorts entering the labour force. This supports the expansion of domestic consumer markets and underpins stronger potential growth rates. The challenge, however, is that economies must generate sufficient employment opportunities to absorb this growing workforce, helping to mitigate risks associated with youth unemployment and underemployment.
Finally, the opportunity for EM economies to accelerate their development through technological convergence offers a further tailwind. Gerschenkron’s 1951 thesis highlighted how Britain’s industrialisation catalysed rapid industrial development elsewhere. It is reasonable to expect a similar dynamic during the current technological revolution. Combined with favourable demographics, this convergence offers scope to increase productivity and shift towards higher value-added sectors, rather than relying predominantly on labour-intensive primary industries.
