Positioned for the future? Emerging market bond weightings in global portfolios

In 2023, emerging markets accounted for 37% of global output in US dollar terms.[1] According to our own conservative estimates, this is set to increase to 46% by 2050.  OECD estimates are even higher, with forecast weightings set to rise to 56%. Around this time China may have overtaken the US as the world’s largest economy and India will most likely be the third largest.

We believe this has important implications for investors. The capital asset pricing model assumes that only the market portfolio—a portfolio that includes every asset in the investable universe in proportion to its market weight—minimises volatility for any given return. On that basis, surely investors ignore a large asset class, and one that is imperfectly correlated with other assets, at their peril?

So, is the growing presence of emerging markets reflected in global portfolios? To answer this question, we’ve looked at an IMF dataset that provides information about the holders of emerging and developed market sovereign debt. Specifically, we asked whether the weight of emerging market debt in global investor portfolios mirrored the weight of emerging markets in outstanding sovereign debt.

As shown in Figure 1., emerging markets account for close to 30% of all outstanding sovereign debt globally. However, global investors hold less than 15% of their sovereign debt portfolios in emerging markets. Most of this gap is attributable to China. Once we exclude China, global investors are much less underweight in emerging markets. That said, the investment implications are not clearcut. Considering rising geopolitical tensions and possible ESG considerations, investors may well decide to remain underweight China for now.

Figure 2. shows positioning on a country-by-country basis. The other country that stands out as being under-represented in global portfolios is India. While Indian sovereign debt accounts for close to 3.5% of all outstanding sovereign debt, global investors typically allocate a mere 0.5% of their sovereign debt portfolios to India. Since India has no hard currency debt, the underweight position refers to local currency debt.

Investors have been absent from India’s local currency bond market due to implicit and explicit capital controls. Those controls are being dismantled. For example, in 2020 India announced a ‘fully accessible’ list of bonds that were no longer subject to non-resident investment limits. These bonds will be included in the GBI-EM Index and the Bloomberg EM Local Index as of June and January, respectively. Inclusion in the Bloomberg Global Aggregate Index and the FTSE World Global Bond Index is still outstanding.

Goldman Sachs estimates that the inclusion in all indices could lead to US$130-US$160bn of inflows. Based on the IMF data, inflows of US$500bn would be needed to bring India’s portfolio weight in line with its market weight. This would, of course, require all government bonds to be freely accessible, from a current share of about 15%.

Reflecting the light positioning in Indian sovereign debt, together with sound macroeconomic fundamentals and good growth prospects, our conviction in Indian sovereign bonds remains strong.

[1] Source: IMF, World Economic Outlook. This comprises the top 23 emerging markets. EMBIG (Core Emerging Markets Bond Index – the main benchmark for EM hard currency sovereign debt) constituents on the other hand account for 39%, while GBI-EM (Government Bond Index – a key benchmark for EM local currency sovereign debt) constituents account for 28%.