Q: Frontier markets are being positioned as a 2026 opportunity — how resilient is that carry-to-volatility story if global conditions turn, particularly with a stronger dollar or risk-off flows?
A: We view frontier markets, particularly local frontier markets, as more insulated than most fixed income assets. During both the 2020 Covid sell-off and the 2022 risk-off episode, local frontier markets outperformed most fixed income sub-asset classes, helped by short duration and managed currencies. The pattern has continued this year: at the market trough, our frontier debt fund remained more than 1% positive year-to-date while all fixed income indices we track were negative. This is partly due to the very short duration of most instruments, and partly due to the managed currencies we see in many places.
Q: In a sell-off, how quickly can you realistically exit positions in markets like Benin or Côte d’Ivoire? How do you price that liquidity risk today?
A: Hard currency markets such as Benin and Côte d’Ivoire ( West African countries) are relatively liquid and can be exited in most market environments. Some local frontier instruments are less liquid, but Bloomberg’s analysis suggests more than 95% of our frontier fund could be liquidated within a couple of days even under stressed market conditions. Liquidity in both hard and local currency frontier markets is significantly better than five to 10 years ago.
Q: You’ve said active management still delivers in EM debt — where is that alpha coming from now: credit selection, FX, duration, or market inefficiencies?
A: Market-cap-weighted equity indices reward companies that become more valuable with larger weightings, which makes sense. Fixed Income indices, on the other hand, reward issuers for increasing their leverage, which isn’t always sensible. A good active manager can deliver performance in fixed income. A good investment process spreads that alpha across multiple sources, though ours puts the main focus on security selection.
Q: What are the metrics you use to distinguish fundamentally different markets like Chile and Peru from distressed credits such as Venezuela or Ecuador?
A: Ecuador is far from a distressed credit today, despite having been one not long ago. For higher-rated markets such as Chile and Peru, we focus on long-term credit trends and relative value opportunities across issuers, countries and yield curves. In distressed situations, we use the IMF’s debt sustainability analysis framework to model restructuring outcomes and recovery values. Historically, this has helped us avoid some of the worst-performing default stories, including Lebanon.
Q: EM debt has shown resilience despite geopolitical shocks — are markets correctly pricing risk, or is there some complacency building in spreads?
A: The answer is somewhere in between. Fixed income spread assets generally look expensive on spreads, suggesting some complacency, but all-in yields remain attractive. Emerging market fundamentals are also strong, with ratings upgrades outpacing downgrades and central bank policymaking improving, helping justify tighter spreads.
Q: Should frontier local currency debt be viewed as a strategic allocation within EM, or is it still a tactical trade driven by yield opportunities?
A: Frontier debt, in general, should be considered a strategic allocation. For very large funds, it could make sense to have both frontier hard and local currency through the cycle, but we still believe the best way to structure a fund is to invest across both, with a dynamic asset allocation. This allows for diversification benefits through the cycle. If the allocation is managed well, it can help dampen the volatility of the hard currency component on the downside, but also capture the capital appreciation when spreads widen.
Q: What would need to happen for frontier local currency debt to move from a niche allocation to a core holding for institutional investors?
A: Liquidity and access would need to improve. To trade in local frontier markets requires a lot of in-depth knowledge about how each market trades, and the various instruments available. It also requires an operational setup with local market accounts, etc. Additionally, some local frontier markets remain quite illiquid. Access to data is often limited, particularly historical data, which makes it challenging to map in any analysis. An index could solve this part if back-dated far enough.
