(March 24): The rally in emerging-market local-currency bonds is getting more exotic, as investors seek to shield themselves from US-induced risks by venturing deeper into lesser-known frontier nations.

William Blair has bought bonds in Jamaican dollars, Dominican Republic pesos, Pakistani rupees, and Zambian kwacha. Meanwhile AXA Investment is holding securities in the Kazakh tenge, Ninety One is mulling Ugandan shilling notes, Pinebridge is evaluating Uzbekistani soum bonds and BlackRock Inc has added Serbian dinar debt to its portfolio.

Money managers are increasingly making off-benchmark allocations, leaving currency risk unhedged as they seek the juiciest yields fixed income has to offer. They are targeting markets that are relatively insulated from the global economy, with investment opportunities led by local drivers like growth, reforms or high interest rates.

“We have a combination of what we view to be very undervalued currencies with very high carry, very high interest rates,” said Marcelo Assalin, who heads William Blair’s emerging-market debt team. “They tend to be uncorrelated to global markets, and that’s the beauty of it.”

In the past, investors diversifying into frontier nations often bought sovereign dollar bonds to avoid exchange-rate risks and stuck to names in benchmark indexes. That is changing, with investors going further off-grid in search of high yields and a hedge against global turmoil.

But there’s a trade-off: they’re swapping global risks — like Trump’s mercurial tariff policies — for local perils. These under-the-radar markets typically have low liquidity and can trap investors in case of a sudden downturn. Unexpected political and economic events can turn gains into losses overnight. Their tiny sizes also limit the scope of the investment opportunity.

“You need to be picky and you need to be doing your research because these markets are less known, less well covered,” said Aurelie Martin, an economist and investment analyst at Ninety One in London.

To be clear, fund managers making these unconventional bets aren’t turning their backs on mainstream emerging markets.

In fact, local-currency bond gains so far this year are being led by the bigger countries. Brazil, Mexico and Chile have delivered returns of more than 8% each, sending Bloomberg’s benchmark for the asset class to its best start since 2023. High-yielding nations such as Egypt, where interest rates are north of 20%, are luring carry traders. 

In comparison, returns from lesser-known frontier markets have been modest. The iShares JPMorgan EM Local Currency Bond ETF, which has smaller-nation securities among its top-10 holdings, is up 3.9% since the start of 2025. That’s more than twice the gains in the Bloomberg EM Local Currency Government Universal Index, but far less than, say, Brazil, where investors earned 14%.

Still, the case for stepping off the beaten path lies in diversification, according to Magda Branet, head of emerging markets and Asia fixed income at AXA Investment Managers UK.

With minimal correlation to global markets, frontier nations can escape market contagions — a potential advantage at a time when investors anticipate a volatility surge in the months ahead.

“When you go into frontier markets, you’re not really playing the global dollar weakening theme,” said Branet. “You have to like the currency in order to go into the trade.”

Branet, whose fund holds tenge bonds in Kazakhstan, said she didn’t hedge for the currency risk as that would eat into the carry returns.

Currently, larger markets like Brazil are outperforming due to a weaker dollar. If the greenback rallies again, it could spark large outflows. In contrast, funds expect substantial yields in frontier markets that can offset potential currency losses while still delivering profits.

Uzbekistan, for instance, offers a 17% coupon on its September 2034 soum-denominated bond. Pakistan’s 10-year rate is 10.5%. Kazakhstan’s March 2035 note carries a 10.25% interest, while Jamaica’s five-year security pays 11.875% annually.

“We see reform momentum and improving credit fundamentals,” said Joseph Cuthbertson, sovereign analyst at PineBridge Investments, referring to Uzbekistan. “The currency is on a credible crawling peg, and the bond yields are attractive after adjusting for any FX depreciation.”

Yet, the risk of a sharp currency loss is never far away. The political flare-up in Turkey underscores how well-laid investment cases can unravel even in mainstream emerging markets.

“It’s a question of being a bit more disciplined and more clear-minded than usual,” AXA Investment’s Branet said.

Uploaded by Arion Yeow