Across the asset class of emerging market debt, upgrades are far outpacing downgrades. As a result, more than 50% of emerging market fixed income investments have become investment grade, says Luz Padilla, senior portfolio manager of the emerging markets fixed income strategy at DoubleLine Capital in Los Angeles.

However, Padilla sees three potential risks going forward to the feel-good story of emerging market debt. These include:

  1. The European debt crisis
  2. The impact of the U.S. election and risks entailed by the coming “fiscal cliff”
  3. Slowing global growth overall

“We have started to see global growth projections being ratcheted down,” Padilla says, adding that even China is posting lower growth trajectories.
How these three forces will play out remains to be seen, she says, noting that they could put a crimp in the double-digit returns that emerging market debt has posted over the past 20 years.  The years that were exceptions were 1994, 1998 and 2008, during the recent recession, when the asset class posted negative returns, she says.

To navigate uncertainty in the class, Padilla says she focuses her investments in the investment grade group and puts money into industries like mining, utilities, telecommunications and top-tier bank.

The financial crisis in the U.S. nearly five years ago demonstrates that countries will prop up their banks at all costs, according to Padilla. In both emerging and developed markets, critical services always enjoys protected status in both emerging and developed market economies.

“They will always support those companies and those industries,” Padilla says. “It’s not just something that sounds good, it’s something we’ve actually seen in practice.”