MFS® Emerging Markets Debt Strategy - Quarterly Portfolio Update
Katrina Uzun, Institutional Portfolio Manager, shares the team's thoughts on emerging markets and provides a quarterly update on the Emerging Markets Debt Strategy.
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.
Distributed by: U.S. - MFS Investment Management; Latin America - MFS International Ltd.; Canada - MFS Investment Management Canada Limited. Please note that in Europe and Asia Pacific, this document is intended for distribution to investment professionals and institutional clients only. U.K./EMEA – MFS International (U.K.) Limited (“MIL UK”), a private limited company registered in England and Wales with the company number 03062718, and authorized and regulated in the conduct of investment business by the U.K. Financial Conduct Authority. MIL UK, an indirect subsidiary of MFS, has its registered office at One Carter Lane, London, EC4V 5ER UK/MFS Investment Management (Lux) S.à r.l. (MFS Lux) – MFS Lux is a company is organized under the laws of the Grand Duchy of Luxembourg and an indirect subsidiary of MFS – both provides products and investment services to institutional investors in EMEA. This material shall not be circulated or distributed to any person other than to professional investors (as permitted by local regulations) and should not be relied upon or distributed to persons where such reliance or distribution would be contrary to local regulation; Singapore – MFS International Singapore Pte. Ltd. (CRN 201228809M); Australia/New Zealand – MFS International Australia Pty Ltd (“MFS Australia”) (ABN 68 607 579 537) holds an Australian financial services licence number 485343. MFS Australia is regulated by the Australian Securities and Investments Commission.; Hong Kong – MFS International (Hong Kong) Limited (“MIL HK”), a private limited company licensed and regulated by the Hong Kong Securities and Futures Commission (the “SFC”). MIL HK is approved to engage in dealing in securities and asset management regulated activities and may provide certain investment services to “professional investors” as defined in the Securities and Futures Ordinance (“SFO”).; For Professional Investors in China – MFS Financial Management Consulting (Shanghai) Co., Ltd. 2801-12, 28th Floor, 100 Century Avenue, Shanghai World Financial Center, Shanghai Pilot Free Trade Zone, 200120, China, a Chinese limited liability company regulated to provide financial management consulting services.; Japan – MFS Investment Management K.K., is registered as a Financial Instruments Business Operator, Kanto Local Finance Bureau (FIBO) No.312, a member of the Investment Trust Association, Japan and the Japan Investment Advisers Association. As fees to be borne by investors vary depending upon circumstances such as products, services, investment period and market conditions, the total amount nor the calculation methods cannot be disclosed in advance. All investments involve risks, including market fluctuation and investors may lose the principal amount invested. Investors should obtain and read the prospectus and/or document set forth in Article 37-3 of Financial Instruments and Exchange Act carefully before making the investments.
Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.
FOR INVESTMENT PROFESSIONAL USE ONLY. Not intended for retail investors.
MFS Fund Distributors, Inc., Member SIPC, Boston, MA
Hello, and thank you for taking a few minutes to review some of the recent developments and key issues shaping the emerging market fixed income asset class. I am Katrina Uzun, an institutional portfolio manager responsible for overseeing Emerging Markets Debt strategies at MFS. I will start with the performance.
January got off to a strong start as everyone talked about the new administration’s plans for deregulation and tax cuts. Spreads kept tightening on talks of “US exceptionalism,” and high-yield credits outpaced investment grade. We saw impressive returns from defaulted countries like Lebanon and Venezuela, each posting returns north of 20% for the month, but also other high-yield issuers like Ecuador delivered double digit returns.
But then in February and March, investor sentiment took a turn for the worse. Concerns around tariffs and softer US macro data pushed credit spreads wider. Over the full quarter, even though spreads widened, overall returns were still firmly in positive territory at just over 2%, as you can see on the bottom left-hand side of this chart, driven by big rally in US Treasuries. Investment grade actually outperformed high yield for the quarter.
The local currency asset class outperformed hard currency assets, returning over 4% in US dollar terms. For the past decade, the dollar has been the go-to currency for investors from Europe, Japan and beyond due to its outperformance and better yields, but now, concerns about tariffs cutting into profit margins and real incomes are starting to surface. That’s raising some questions about how long the dollar strength can last, and it’s giving a boost to emerging markets local currency returns.
So what are our expectations for this year? Heading into 2025 things looked pretty encouraging: global growth was hanging in there, inflation was finally easing off (so central banks could start talking about rate cuts) and China was starting to pick up steam again. Then the US ramped up tariffs, and suddenly that upbeat storyline got a lot choppier. How much the world slows down really comes down to how big those tariffs get — and how long they stick around.
China, Canada and Mexico are the three largest exporters of goods to the US, they account for 40% of total imports, so it’s not a surprise that they were the first to be targeted in the recent tariff announcements. Our take is that most emerging markets outside of China will likely focus on negotiating first rather than immediately retaliating with their own tariffs.
When it comes to China, as you can see on this chart, Chinese exports to the US have already been declining over the recent years, while exports to emerging markets have helped support growth. Structurally, we believe China’s economy is in a better position than it was a couple of years ago, having addressed some of the structural imbalances. Before escalation in March, business sentiment was improving, the housing market was stabilizing and fiscal stimulus was effectively boosting consumption.
That said, tariffs - especially if they remain at elevated levels above 60% - pose a real headwind for the external sector and raise concerns about employment, especially among the small and medium size enterprise sectors. Additional stimulus is likely to partially offset the tariff drag, but nonetheless China’s promising recovery is probably deferred for now.
Over in Europe, Germany has unveiled a once-in-a-generation boost to infrastructure and defense spending, which could help lift euro-area growth as we head into next year. And if China rolls out fresh fiscal stimulus to offset tariff-related pressures, it could not only accelerate its own growth but the rest of the world’s too.
In that scenario, the dollar would likely cool or even dip and emerging-market assets would really benefit. It means their currencies gain strength, and their central banks get the flexibility to cut rates more aggressively, giving them room to navigate in the face of potential shocks. On top of that, lower oil prices help keep inflation contained, and combined with rate cuts, they could help boost domestic economies.
So in terms of our positioning in hard currency debt strategies, we’ve kept our defensive risk stance and overweights in double-B sovereigns — Paraguay and Costa Rica — because they have healthy balance sheets and manageable current accounts. We met with the government officials from Paraguay last week, and they confirmed their commitment to maintaining the macro prudential framework and fiscal policy and we expect the reduction in fiscal deficit to 1.5% next year. Many of these BB-rated economies are pushing through reforms that could earn them investment-grade ratings in the next few years.
We’ve dialed back our duration overweight in local currency debt portfolios and are searching for the best risk-adjusted carry opportunities. Right now, we like local rates in the Czech Republic, Poland and Mexico. On the currency front, we’re keeping a broadly neutral stance but leaning into defensive, high-carry plays — specifically the Serbian dollar, the Uruguayan peso and the Turkish lira. We met with the CB governor and Minister of Finance of Uruguay at IMF meetings, and they remain committed to maintaining monetary framework. The previous government moved to an inflation targeting regime, which was a big step for the economy, and the current government is committed to staying the course, which is good to see.
But it goes without saying that the global markets will likely remain volatile, and in this environment, it is that much more important to have a robust investment process, strong risk management and an active approach to investing.
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.
Distributed by: U.S. - MFS Investment Management; Latin America - MFS International Ltd.; Canada - MFS Investment Management Canada Limited. Please note that in Europe and Asia Pacific, this document is intended for distribution to investment professionals and institutional clients only. U.K./EMEA – MFS International (U.K.) Limited (“MIL UK”), a private limited company registered in England and Wales with the company number 03062718, and authorized and regulated in the conduct of investment business by the U.K. Financial Conduct Authority. MIL UK, an indirect subsidiary of MFS, has its registered office at One Carter Lane, London, EC4V 5ER UK/MFS Investment Management (Lux) S.à r.l. (MFS Lux) – MFS Lux is a company is organized under the laws of the Grand Duchy of Luxembourg and an indirect subsidiary of MFS – both provides products and investment services to institutional investors in EMEA. This material shall not be circulated or distributed to any person other than to professional investors (as permitted by local regulations) and should not be relied upon or distributed to persons where such reliance or distribution would be contrary to local regulation; Singapore – MFS International Singapore Pte. Ltd. (CRN 201228809M); Australia/New Zealand – MFS International Australia Pty Ltd (“MFS Australia”) (ABN 68 607 579 537) holds an Australian financial services licence number 485343. MFS Australia is regulated by the Australian Securities and Investments Commission.; Hong Kong – MFS International (Hong Kong) Limited (“MIL HK”), a private limited company licensed and regulated by the Hong Kong Securities and Futures Commission (the “SFC”). MIL HK is approved to engage in dealing in securities and asset management regulated activities and may provide certain investment services to “professional investors” as defined in the Securities and Futures Ordinance (“SFO”).; For Professional Investors in China – MFS Financial Management Consulting (Shanghai) Co., Ltd. 2801-12, 28th Floor, 100 Century Avenue, Shanghai World Financial Center, Shanghai Pilot Free Trade Zone, 200120, China, a Chinese limited liability company regulated to provide financial management consulting services.; Japan – MFS Investment Management K.K., is registered as a Financial Instruments Business Operator, Kanto Local Finance Bureau (FIBO) No.312, a member of the Investment Trust Association, Japan and the Japan Investment Advisers Association. As fees to be borne by investors vary depending upon circumstances such as products, services, investment period and market conditions, the total amount nor the calculation methods cannot be disclosed in advance. All investments involve risks, including market fluctuation and investors may lose the principal amount invested. Investors should obtain and read the prospectus and/or document set forth in Article 37-3 of Financial Instruments and Exchange Act carefully before making the investments.
Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.
FOR INVESTMENT PROFESSIONAL USE ONLY. Not intended for retail investors.
MFS Fund Distributors, Inc., Member SIPC, Boston, MA
51885.12