While passive investing is increasingly gaining market share in many asset classes, we believe one of the most attractive areas of Emerging Markets Fixed Income remains ripe for active management. The very nature of market cap weighted indices has always given me pause when it comes to fixed income. In equities, sure, a more valuable company gets a larger allocation.
Seems sensible enough. But in fixed income, the more debt a country or company issues, and the more leverage it takes on, the larger the weighting in a market cap weighted index. With active management we believe we can do better, and the track record of the various funds our team manages bears this out. While this phenomenon applies to all fixed income indices, we believe those that cover less established markets are even more propitious for alpha generation.
Currently, our favourite part of the EMD investment universe happens to be in exactly such an area – Frontier Markets. To be completely honest, saying we can outperform ETFs in this market is kind of cheating, as no Frontier Debt ETF exists! While there is an index covering the sovereign hard currency frontier markets, to my knowledge, no ETF exists that tracks it. And in local frontier markets it gets even more interesting, as yet we find no good index at all covering these markets.
As to why we like Frontier Markets in 2026, it comes down to the concept of carry-to-volatility. We (and most global investors we speak to) find many fixed income sub-asset classes to be on the expensive side, at least when it comes to spreads. Across US or European assets, investment grade or high yield, spreads are near historical tights. The same is the case in emerging markets.
While we do find attractive real yields in many local markets, the current oil price picture brings the potential for higher rates to eat into some of this. So, with limited room for capital appreciation, we think most of the returns in fixed income assets this year are going to come from carry. On the positive side, carry at the index level actually sits slightly higher than the average level of the past decade.
We believe the right strategy at the macro level is to seek to maximise the level of carry, while keeping volatility as low as possible – i.e., carry-to-volatility. The highest carry to volatility we can find tends to be in local frontier markets, as these markets tend to be less correlated with broader risk, which is highly relevant when markets are driven by broader macro themes, as we are seeing today. As such, this is the part of the asset class we find ourselves drawn to, and that we are putting in portfolios, where it fits.
When it comes to generating alpha we believe it is best done from the bottom-up, through deep, rigorous, fundamental analysis. Within the scope of country analysis, one thing that we find outdated is the concept of regional coverage. It seems a lot of peers are still trying to hold onto this, but we believe it to be completely irrelevant in today’s world.
Many of us who have been investing in Emerging Markets for a couple of decades or more may consider that “Emerging Markets” is perhaps too broad of a term, as EM countries come in vastly different shapes and sizes. Well, we believe the same to be true at the regional level. Covering “Latin America” means looking at investment grade countries with strong institutions, like Uruguay or Chile.
But it also means covering countries recovering from recent defaults, like Argentina and Ecuador, and also special situations such as Venezuela. Many of these countries have nothing in common from an investment perspective. A better peer for Uruguay or Chile would certainly be Malaysia or Philippines. And a comparison for Venezuela would surely be Lebanon, another country stuck in default for more than half a decade. If the idea is to uncover relative value, and optimise risk allocation, as we believe it should be, then grouping countries based on economic modalities, and credit fundamentals strikes me as a lot more prudent.
So that’s how we are spending our time investing our clients’ money. Looking for the best assets to express our views on the various companies and countries we invest in, while maximising the carry-to-volatility of our funds. And that’s how we intend to continue to demonstrate the ability to generate significant alpha and prove that active management still works.
