Emerging market (EM) assets have continued to perform well this year despite geopolitical headwinds and a generally stronger U.S. dollar. Figure 1 shows that, after several years of structurally lower Sharpe ratios – a gauge of risk-adjusted return – the asset class has begun to recover. EM credit, in particular, has delivered one of the strongest risk-adjusted performances across fixed income over the past two years. The more interesting question, however, is no longer whether EM has been worth owning, but how to own it from here.
Figure 1: After a difficult start to the 2020s, EM Sharpe ratios have recovered
Source: Bloomberg, PIMCO. Data as of 11 June 2026. Based on EM USD Aggregate and EM Local Currency Government Universal Index data. Sharpe ratios are calculated using the average monthly total returns over the 3-month T-bill rate divided by the volatility of total returns over the same period. Sharpe ratios are annualized.
Part of that outperformance reflects higher starting yields and the extra compensation investors demand for EM’s higher volatility. But that is not the whole story. Figure 2 compares year-to-date total returns with those of a ratings-matched U.S. dollar high yield (USD HY) benchmark constructed to mirror the EM HY index’s BB, B, and CCC rating weights. (While EM debt is now mostly investment grade, here we are focusing on the HY component as an analytical exercise.) Even on that basis, and even after stripping out duration, EM has outperformed USD HY. Relative-value advantages of this significance can be a feature of maturing asset classes – and tend to compress as that maturation progresses.
Figure 2: EM credit has outperformed a ratings-matched and risk-adjusted USD HY portfolio in total returns
For multi-asset fixed income investors, the more relevant question is what EM adds to a broader portfolio. Figure 3 addresses that directly by comparing ex-post annualized Sharpe ratios for portfolios with and without EM. Starting from a baseline mix of 60% Agg, 20% IG, and 20% HY, we then add EM external and local assets, funded from HY and Agg. We see that EM has lifted total returns without reducing return per unit of risk.
Figure 3: Adding EM to a baseline portfolio improves both absolute and risk-adjusted return
A shifting opportunity
How durable is this EM recovery? On many metrics, this is not the EM fixed income universe of past cycles. The external vulnerabilities that defined earlier EM crises have given way to more common risks like domestic and fiscal considerations, which typically evolve more gradually.
Deep local rates markets, often funded by domestic savings, have largely reduced the foreign exchange (FX)-mismatch vulnerabilities that shaped the late 1990s. At the same time, many EM central banks strengthened their credibility after COVID by hiking interest rates ahead of the Federal Reserve and engineering soft landings for their economies.
Taken together, these shifts argue for structurally lower risk premia than history would suggest and support EM fixed income’s continued role in multi-asset portfolios. At the same time, the maturation that has compressed the beta opportunity is now widening the dispersion across issuers, sovereigns, and curves.
From here, the forward Sharpe story is increasingly idiosyncratic: The same valuation constraints facing developed market (DM) credit portfolios also loom large in EM credit, shifting the opportunity set toward more selective situations. In local rates, as in G10, the repricing of the front end of yield curves after the Iran shock leaves room for some relief if tensions ease, particularly in high-yielding markets.
But dispersion is likely to remain elevated given differing domestic macro fundamentals. Inflation, for example, is still rising in parts of EM, notably Asia, where policy remains accommodative and limits the scope for a sustained rally. By contrast, markets such as South Africa and Mexico – where policy is restrictive and inflation appears closer to peaking – look better positioned for more durable gains.
