Yield curves have become more developed, allowing active investors to add value via positioning across different maturities. As both of these factors have improved, the ownership mix has diversified, with a greater balance between foreign and domestic owners. Indeed, the establishment of a mature local currency EM bond market and the effective management of interest rate policy are key indications of a country’s ongoing economic development.

The rationale for a strategic allocation to local currency EMD is strong given the diversification benefits and potential for strong returns driven by attractive yields; but how best to manage such exposure? An allocation to passive or smart beta strategies can provide an effective and low-cost way to access the broad market. However, these approaches can lead to exposure biased towards countries with higher levels of indebtedness, without considering the direction of travel with regards to economic policy. They can also restrict opportunities to capture relative value through market movement. Interest rate and exchange rate volatility can at times be high; an active approach can help to mitigate this.

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