MFS® Emerging Markets Debt Strategy - Quarterly Portfolio Update

Hello, and thank you for taking a few minutes to dive into some of the recent developments, and key issues shaping the emerging markets fixed-income asset class. I am Katrina Uzun, an institutional portfolio manager responsible for overseeing Emerging Markets Debt strategies at MFS.  There is certainly no shortage of important topics to address, so let’s get started.  

I will begin with performance, because it really stood out last year. The emerging markets hard currency asset class had an impressive year, especially when you consider the environment – elevated US rate volatility, worries about US and global growth and heightened geopolitical risks.  Despite these challenges, emerging markets hard currency sovereign credit spreads compressed in 2024. This spread compression, combined with elevated carry accumulation, pushed total returns to 6.5% for the year, making emerging markets hard currency debt one of the best performing fixed income asset classes.

In fact, emerging markets hard currency outperformed EM local debt, which ended the year down 2.5% in USD terms.  The underperformance of the local currency debt was largely driven by US dollar strength.  Interestingly, though, if you look at the Index returns in EUR terms, local currency debt actually delivered a positive 4% return, highlighting the strength of the emerging markets fundamentals.

Speaking of fundamentals, take a look at this chart.  It shows just how resilient emerging markets are from an external perspective.  US dollar-denominated external debt has been declining as a percent of GDP in recent years. 

Current account deficits remain modest and are mostly financed by foreign direct investment and strong currency reserves.  Many emerging markets countries are also making fiscal adjustments, and while there are macro imbalances in several larger EM economies, these shouldn’t be particularly concerning provided the ongoing adjustments continue.

All of this points to an asset class that has the ability to weather global shocks.

Looking ahead over the next 12 months, our outlook for emerging markets debt is broadly positive.  We expect global growth to remain resilient driven by robust US growth, global monetary policy easing and stable growth in China due to continued fiscal support aimed at boosting consumption growth.

We expect tariff hikes to have a moderate impact on China.  In response, Chinese authorities will likely allow the currency to weaken, though they’ll aim to control the extent and magnitude of that weakness to avoid triggering capital outflows. 

So, where does that leave us for the returns in the asset class?  We’re expecting carry-driven total returns this year. 

It’s worth noting that emerging market yields, both in investment-grade and high-yield segments, are currently above historical medians, which supports this positive outlook.

If you look at the historical data, as shown here, yields at these levels have historically delivered a median return of 10% per annum over a 5-year period. That’s a compelling prospect, especially when compared to other fixed income asset classes.

Of course, this outlook isn’t without risks.  One of the key risks we are closely monitoring is the US trade policy under the new administration.  While it’s not our base case, there is a significant downside risk to global growth if large across-the-board tariffs are implemented.

That said, we don’t expect tariffs to significantly impact EM sovereign creditworthiness.  Many emerging markets countries can offset some of the impact by allowing their currencies to depreciate. 

As shown here, the tariffs imposed during the first Trump administration did not have a noticeable medium-term impact on emerging market credit. While risk assets faced some negative momentum in the first few months, emerging markets ultimately bounced back and performed as well as, or better than, many other asset classes.

That doesn’t mean tariffs won’t create winners and losers.  Countries with large manufacturing and trade exposure to US – like those in North Asia – would likely feel the biggest impact.   Similarly, some European manufacturing exporters, such as Hungary and the Czech Republic, could be affected if tariffs were imposed on the European autos. 

On the other hand, certain countries would be relatively insulated.  Latin American commodity producers and countries with large domestic-driven economies, like India and Brazil, are less exposed to trade risks and would likely fare better in this scenario. 

So, where does this leave us in terms of positioning? With valuations still tight, our focus is more on earning carry than on spread compression.  We are leaning into an “up in quality” strategy, with countries like Chile, the Czech Republic, and Paraguay.  That said, we are open to HY names where there are positive idiosyncratic tailwinds – Nigeria and Uzbekistan are good examples.  We are also finding opportunities in emerging markets corporate debt, where valuations offer attractive risk/reward profiles, particularly in places like India and Chile.            

On the local currency debt side, we are staying underweight in currencies for now.  Near-term factors still favor a stronger US dollar, even though it looks expensive.  This means underweighting countries with relatively weak growth prospects, such as China and Romania. 

For rates, we are taking an overweight stance with selective exposure to emerging markets where valuations look attractive, and balance of payments are supportive.  Examples include Chile, Colombia, Mexico and Uruguay.   

Thank you for your time and trust in us as we continue to focus on creating value responsibly for you, our investors. 

 

Fixed Income Investment Strategies Details

 

The views expressed are those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor. No forecasts can be guaranteed. Past performance is no guarantee of future results.

 

Important Risk Considerations:

The strategy may not achieve its objective and/or you could lose money on your investment.

Bond: Investments in debt instruments may decline in value as the result of, or perception of, declines in the credit quality of the issuer, borrower, counterparty, or other entity responsible for payment, underlying collateral, or changes in economic, political, issuer-specific, or other conditions. Certain types of debt instruments can be more sensitive to these factors and therefore more volatile. In addition, debt instruments entail interest rate risk (as interest rates rise, prices usually fall). Therefore, the portfolio's value may decline during rising rates. Portfolios that consist of debt instruments with longer durations are generally more sensitive to a rise in interest rates than those with shorter durations. At times, and particularly during periods of market turmoil, all or a large portion of segments of the market may not have an active trading market. As a result, it may be difficult to value these investments and it may not be possible to sell a particular investment or type of investment at any particular time or at an acceptable price. The price of an instrument trading at a negative interest rate responds to interest rate changes like other debt instruments; however, an instrument purchased at a negative interest rate is expected to produce a negative return if held to maturity.

Emerging Markets: Emerging markets can have less market structure, depth, and regulatory, custodial or operational oversight and greater political, social, geopolitical and economic instability than developed markets.

International: Investments in foreign markets can involve greater risk and volatility than U.S. investments because of adverse market, currency, economic, industry, political, regulatory, geopolitical, or other conditions.

Derivatives: Investments in derivatives can be used to take both long and short positions, be highly volatile, involve leverage (which can magnify losses), and involve risks in addition to the risks of the underlying indicator(s) on which the derivative is based, such as counterparty and liquidity risk.

High Yield: Investments in below investment grade quality debt instruments can be more volatile and have greater risk of default, or already be in default, than higher-quality debt instruments.

 Please see the applicable prospectus for further information on these and other risk considerations.

 The portfolio is actively managed, and current holdings may be different.

 

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