Emerging-Market Bond Funds Might Be Due for a Correction

Emerging-market bond funds delivered strong returns in 2025, driven by improving fundamentals, renewed investor confidence, a falling US dollar, and the US Federal Reserve’s rate cuts. Spreads on the Morningstar Emerging Markets Composite Bond Index tightened by 30 basis points versus Treasuries, and the emerging-markets bond Morningstar Category gained 13%. Local-currency strategies outpaced hard-currency counterparts, aided by a weakening dollar. The emerging-markets local-currency bond category led all fixed-income categories with a 20% average return—surpassing even the S&P 500’s 18% gain.

Emerging-market bonds typically carry a yield premium over same-maturity US Treasuries to compensate for the added credit, political, currency, and liquidity risks. By year-end 2025, however, this yield premium fell to an 18-year low, according to the Morningstar Emerging Markets Composite Bond Index. As bonds’ prices move inversely with yield, this represents the richest valuation emerging-market bonds have traded at in 18 years. Those returns come with risks to match, however. Over the past 15 years, the three emerging-market debt categories—emerging-markets local-currency bond, emerging-markets bond, and global bond—posted the highest downside-capture ratios among taxable fixed-income categories, using the S&P 500 as a proxy for the broader economy.

With emerging-market bond prices looking richer, it may be time to consider reallocating some of those gains to other opportunities, given the inherent risks these bonds carry. I screened for funds that delivered strong returns in 2025 but experienced the steepest drawdowns during the peak-to-trough period from Sept. 15, 2021, through Oct. 21, 2022. That stretch was especially challenging for emerging-market economies, which were still recovering from the global pandemic and weighed down by the Federal Reserve’s aggressive rate-hiking campaign.

Vanguard Emerging Markets Bond VEGBX, which earns a Morningstar Medalist Rating of Silver, delivered solid returns in 2025. The fund gained 14.5% and outperformed its category benchmark—the Bloomberg Emerging Markets Aggregate Index—by more than 3 percentage points and over half of its emerging-market bond peers. Missed opportunities, such as avoiding Lebanon and Venezuela debt and taking a defensive stance in Egypt, limited upside, but overall results were solid. However, the fund didn’t stand out during tougher times. From Sept. 15, 2021, through Oct. 21, 2022, it plummeted 24.2%, which matched category peers and the Bloomberg benchmark but was significantly worse than the S&P 500’s 14.1% decline.

Bronze-rated Fidelity New Markets Income FNMIX also produced an impressive 2025 result. Its 14.9% return outpaced the category benchmark and topped nearly 70% of distinct peers. An overweighting in Sri Lanka’s recovering sovereign debt and positive corporate bond selection in Mexico led the outperformance. Like Vanguard Emerging Markets Bond, however, the fund struggled during the late-2021 to late-2022 downturn. Its 26% drawdown during that period was more severe than its category benchmark and 12% worse than the S&P 500’s decline.

Finally, Negative-rated Ashmore Emerging Markets Total Return EMKIX is a cautionary tale. The strategy recorded a standout 2025 and gained 17.2%, which beat almost 90% of its peers. But that one-year surge came after years of underperformance. By blending hard- and local-currency debt and taking concentrated bets, the fund suffered heavily during the 2021–22 selloff. Its staggering 36% loss landed among the worst in the emerging-markets bond category and more than double the S&P 500’s pullback over the same period.

This article first appeared in the February 2026 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting this website.