It is tough to beat the long term risk-adjusted returns of emerging markets (EM) sovereign debt. The asset class has consistently delivered steady performance even during poor macroeconomic environments for emerging market economies. On a forward-looking basis, a simple quantitative analysis demonstrates investors receive six to ten times more spread over US Treasury than the actual default risk embedded in EM sovereign. Investors often mistake the asset class as having the same risk-premium as to the United States (US) or European (EU) high yield (HY) corporate bonds, but the risks are fundamentally different. EM sovereign debt offers geographical and macro-economic diversification. Furthermore, sovereign debt investors are backed by a more robust legal framework that minimises loss given default in unfortunate incidents.

The persistent mispricing of EM sovereign debt is partially due to broad ownership from ‘tourist investors’. In our opinion their biases, prejudices and limited ability to analyse the credits can lead to an excessive risk premium. Lastly, supply and demand dynamics favour Emerging Market sovereign debt over the long term. Most large long term investors remain structurally underweight in an asset class where they should be structurally invested and using sell-off as opportunities to go overweight.