The allocation gap
Pension funds face an uncomfortable arithmetic. Their members are living longer, their liabilities are lengthening, and the economies in which they have traditionally invested are ageing alongside them. The populations that will drive global consumption and credit demand over the coming decades are young and concentrated in emerging and frontier markets: Africa's median age is around 19, according to Pew Research Center analysis of UN population data, and the continent is home to 28% of the world's under-25s. Capital sits where growth is slowing; growth sits where capital is scarce.
Debt is the most natural bridge between the two. Yet institutional portfolios remain strikingly underexposed.
- A 2026 survey by emerging markets manager Gemcorp Capital of 250 senior institutional investors with combined assets of USD 21 trillion found that, on average, only 5.8% of their private credit portfolios were allocated to emerging markets – and 40% had no such exposure at all.
- Appetite is shifting: 42% intend to raise their allocation over the next two years (only 25% in North America), and 52% expect emerging market private credit to return 11–15% a year over the next five years, against roughly 8% for developed markets. Coming from a specialist manager, those expectations deserve a discount – but the allocation gap itself is hard to dispute.
Is that caution prudent, or is it a blind spot? The honest answer is that it can be either.
The case for
The risk is lower than the reputation. For decades, investors priced emerging market credit on anecdote. That excuse has expired. In October 2025, the Global Emerging Markets Risk Database (GEMs) – a consortium of 29 multilateral development banks and development finance institutions – published three decades of lending statistics covering more than 10,000 private borrowers in 169 countries.
|
GEMs segment |
Avg. annual default rate |
Avg. recovery rate |
|---|---|---|
|
Private lending (1994–2024) |
3.54% |
72.9% |
|
– of which financial sector |
2.26% |
79.1% |
|
– of which Sub-Saharan Africa |
6.05% |
78% |
|
Public (non-sovereign) lending (1994–2024) |
2.61% |
85.8% |
|
Sovereign and sovereign-guaranteed (1984–2024) |
0.77% |
95.1% |
Source: GEMs Consortium, October 2025. Figures reflect lending by multilateral development banks and development finance institutions, not by private investors.
A private default rate of 3.54% is comparable to that of private firms in advanced economies. Lending to financial institutions – the backbone of microfinance and small-business finance – recorded the lowest default rate of any sector and one of the highest recoveries. Even Sub-Saharan Africa, the region with the highest default frequency, posted the strongest regional recovery rate.
The carry is real. Listed hard-currency sovereign debt, measured by the J.P. Morgan EMBI Global Diversified Index, returned 14.3% in 2025. At the end of August 2026 the index still yielded 7.20% in US dollars. Private debt to emerging market lenders adds a further premium for illiquidity and complexity: established microfinance debt funds typically target net returns of two to three percentage points above SOFR (the Secured Overnight Financing Rate, the benchmark cost of overnight US-dollar borrowing), with currency exposure hedged back into dollars.
Diversification arrives when it matters. GEMs data indicate that during global crises, emerging market default rates held up better than widely assumed. At a time when developed-market private credit is under scrutiny – in spring 2026, BlackRock's USD 26 billion HPS Corporate Lending Fund gated redemptions after USD 1.2 billion of withdrawal requests, and Blue Owl moved to wind down a non-traded BDC – a sleeve of emerging market private debt, lending to regulated banks and microfinance institutions rather than to leveraged buyouts, offers exposure to a genuinely different credit cycle.
The purpose aligns with the beneficiary. A pension fund exists to pay pensions decades from now. Financing financial inclusion, clean-energy access and small-enterprise growth in the markets that will anchor the global economy of 2050 is not a departure from fiduciary duty. For many members, it is an expression of it. Switzerland is well placed here: Geneva and Zurich host several of the world's largest microfinance and development-finance debt managers, so Swiss boards need not look far for specialist expertise.
The case against
Spreads leave little room for error. The listed market's strong run has compressed compensation. The EMBI Global Diversified spread ended the second quarter of 2026 at 235 basis points – 53 basis points tighter over the quarter – and was still at 235 at the end of August, close to historically tight levels. The path there was not smooth: a Middle East oil shock pushed the index into negative territory in the first quarter, and year-to-date returns to August stood at a modest +2.75% for hard-currency sovereigns, +2.74% for local-currency bonds and +2.35% for corporates. Entering at tight spreads means accepting volatility without being generously paid for it.
The GEMs record is not automatically yours. Development banks benefit from preferred creditor status, local presence and political leverage that a pension fund investing through a Luxembourg fund vehicle does not possess. The consortium's own members stress that investors mobilising capital alongside development institutions are more likely to achieve comparable outcomes. That is an important qualifier, not a guarantee.
Currency is the silent tax – twice over for Swiss investors. Most frontier borrowers earn in local currency. Either the lender hedges, at a cost that in thinly traded currencies can absorb much of the spread, or the borrower carries the mismatch, which simply converts currency risk into credit risk. A Swiss pension fund then pays a second time to hedge the resulting US-dollar exposure back into francs – a cost driven by the interest rate gap between the dollar and the franc. There is no free option.
Liquidity promises deserve scepticism. 2026 has reminded allocators that semi-liquid private credit vehicles can restrict redemptions when withdrawals cluster; gates of around 5% of net asset value per quarter are standard. A fund offering monthly liquidity on loans of two to three years is making a promise that depends on orderly markets. Trustees should test that promise against their own cash-flow and rebalancing needs.
Fees, rules and restructurings erode returns. Total expense ratios in specialist impact debt funds can exceed 1.5% – a substantial share of an excess return of two to three percentage points. Regulation constrains sizing: under BVV 2, Swiss pension funds must treat foreign private debt as an alternative investment, subject to a 15% ceiling unless they formally invoke the ordinance's extension clause and justify it in the annual report; listed emerging market bonds, by contrast, qualify as ordinary bonds. The separate 5% category for non-listed Swiss investments does not help – it is reserved for domestic companies. With alternatives already at 9.8% of the average Swiss pension portfolio (Complementa 2026, see our analysis of Swiss pension funds and the endowment model), emerging market private debt competes for scarce headroom with private equity, infrastructure and hedge funds. And when a sovereign fails, as Zambia, Ghana and Sri Lanka did earlier this decade, resolution is slow and costly: Zambia defaulted in late 2020 and only reached a deal with bondholders in 2024, including an 18% nominal haircut and maturities pushed out to 2035 and 2053 – with losses considerably larger in net present value terms.
The verdict: yes, but not by default
The case against does not argue for abstention; it argues for discipline. Pension funds should hold emerging and frontier market debt, but deliberately, and on terms dictated by their own liabilities rather than by a manager's marketing. Four principles follow.
Size it to the liability profile. A strategic allocation – typically a low single-digit percentage of assets – held through the cycle rather than traded on spread momentum, and sized within the BVV 2 alternatives budget alongside everything else competing for it.
Combine the two markets. Listed bonds supply liquidity and transparency; private debt supplies the premium and the direct impact.
Invest alongside development finance. Co-lending, blended structures or guarantees import the governance, preferred-creditor protection and local knowledge that underpin the GEMs record.
Interrogate the plumbing. Hedging costs (local currency to dollar, and dollar to franc), liquidity terms, fee load and verified outcome data at the level of end borrowers.
The bottom line: patience, not complacency
Longevity is the defining financial challenge of this century. The institutions entrusted with funding it cannot afford to ignore the part of the world where the next generation of workers, savers and borrowers is being formed. Nor can they afford to enter it carelessly. The frontier rewards patience and punishes complacency – which is precisely the discipline pension funds were built to exercise.
Sources: GEMs Consortium, «Default and recovery statistics: Private lending 1994–2024» and press release (7 October 2025); State Street Investment Management, «Emerging market debt outlook: Enduring strength» (January 2026), «Emerging Market Debt Market Commentary: Q2 2026» (July 2026) and «August 2026»; Gemcorp Capital institutional investor survey, reported by Alternative Credit Investor and Benefits and Pensions Monitor (June 2026); Pew Research Center, «5 facts about Africa's population growth» (May 2026), based on UN World Population Prospects 2024; HedgeCo, private credit redemption gates (April 2026); Zambia Monitor, Eurobond restructuring agreement (2024); Verordnung über die berufliche Alters-, Hinterlassenen- und Invalidenvorsorge (BVV 2, SR 831.441.1); Complementa, «Risiko Check-up 2026».