“Every financial innovation starts in the United States, then moves to Europe after five to ten years, and eventually reaches emerging markets another decade later,” says Mihai Florian, Senior Portfolio Manager at RBC BlueBay Asset Management. Private credit has followed this same path. While it is a mature and competitive asset class in developed markets, it is still relatively young – and full of opportunities – in emerging markets.

“In developed markets, private credit is a fairly mature and well-defined asset class,” says Florian, part of RBC BlueBay’s Emerging Markets team. “You have clearly delineated segments such as direct lending, infrastructure, real assets, special situations, and distressed opportunities.” By contrast, he adds, “the emerging market side of this universe has only started to take shape over the past seven years or so.”

“In developed markets, private credit is a fairly mature and well-defined asset class. The emerging market side of this universe has only started to take shape over the past seven years or so.”

As the global private credit market has matured, competition among managers has intensified. “When competition increases, two things typically happen,” Florian explains. “Returns are being driven down, and risks start creeping up.” That risk, he continues, stems from increased borrower leverage and weaker documentation standards as managers stretch to deploy capital. In emerging markets, however, the competitive landscape remains far less crowded, with only a few dedicated private credit strategies focused specifically on EMs. “That means from a pure credit perspective, you can get a better profile for which you’re getting a better return relative to risk,” says Florian.

A Saturated Developed Market

Before turning to emerging markets, Florian outlines the current state of private credit globally, especially in direct lending – the sector’s largest component. “Direct lending is typically sponsor-driven, bullet loans linked to private equity acquisitions,” he says. “Repayments are often tied to the private equity exit.” As private equity deal activity has slowed over the past year, repayments of private credit capital have also been delayed.

Compounding this is the legacy of vintages issued during 2020, 2021 and 2022, when base interest rates were close to zero. With current rates now significantly higher – 300 to 400 basis points or more in both the U.S. and Europe – borrowers face pressure. “About a third of borrowers in direct lending either can’t pay interest or are switching to payment-in-kind structures,” says Florian. This further compresses investor returns.

The Case for Emerging Markets

In emerging markets, by contrast, limited alternative financing options allow private credit managers to lend to high-quality borrowers on more favorable terms. “We target corporates with leverage between two to four times EBITDA,” says Florian, “compared to around five times for senior direct lending in developed markets, and up to seven times for unitranche or mezzanine deals.”

In terms of returns, Florian notes that developed market strategies typically yield high single digits. “On a per-turn-of-leverage basis, that equates to about 150 to 200 basis points,” he explains. “In our emerging markets portfolio, the actual returns on deals we are doing are north of 20 percent, with an average leverage of around three times for the underlying corporates. That translates to roughly 700 basis points per turn of leverage.”

“In our emerging markets portfolio, the actual returns on deals we are doing are north of 20 percent, with an average leverage of around three times for the underlying corporates. That translates to roughly 700 basis points per turn of leverage.”

This, he argues, highlights the significant premium available in emerging markets. “You’re essentially getting an extra 500 to 600 basis points per turn of leverage for taking EM risk,” Florian says. “And even on an absolute return basis – 20 percent versus high single digits –there’s a clear emerging markets premium.”

That premium, however, must be seen in the context of risk. “Ultimately, you need to be compensated for the inherent risks of operating in emerging markets,” Florian cautions. “You don’t have the same legal frameworks as in the U.S. or the UK. You need to understand local nuances, such as contract enforcement and jurisdictional peculiarities,” he adds. “These risks are specific to emerging markets, and they require compensation on an absolute return basis.”

“Ultimately, you need to be compensated for the inherent risks of operating in emerging markets.”

“As a private credit manager in emerging markets, you need to find ways to mitigate those risks,” Florian continues. “The legal environment in a country is what it is – you can’t change that.” What managers can do, however, is structure deals in a way that reduces exposure. “For example, we typically set up offshore holding company structures – whether in the Netherlands, Luxembourg, or the UK – where we also take security. This gives us the ability to enforce at the UK level if something goes wrong, rather than having to rely on local enforcement mechanisms right away.”

Managing FX Risk

Another key risk in emerging markets is foreign exchange. “In my view, local currency risk is probably the biggest concern and a major reason why many EM corporates have historically run into trouble,” explains Florian. “In a five-year period, most EM currencies experience sharp and sometimes sudden depreciation.” To mitigate this, the team focuses exclusively on hard currency investments, with most loans denominated in U.S. dollars and some in euros. “From our perspective, mixing illiquidity with local currency is a recipe for disaster.”

Going a step further, the team at RBC BlueBay ensures that underlying borrowers generate revenues in hard currency to service their hard-currency debt obligations. “We would never lend to a local retailer with low margins and local-currency revenues – any currency devaluation would wipe them out if they have dollar liabilities,” Florian says. “Instead, we focus on exporters and commodity producers.”

“From our perspective, mixing illiquidity with local currency is a recipe for disaster. We focus on exporters and commodity producers.”

Florian explains that many emerging market corporates have been managing currency devaluation risks for decades. “If you look at markets like Turkey, Brazil, or Mexico, many corporates have lived with currency volatility for decades. Even if they’re local businesses, they often have contracts in hard currency,” he notes. “Take ports, for example. Most port operators in EMs have contracts denominated in U.S. dollars or other hard currencies. So even when they operate solely within their country, they have embedded hard-currency exposure.”

Underinvested and Underserved

While the private credit asset class in emerging markets remains in its early stages and represents a relatively small opportunity set, RBC BlueBay sees significant room to grow. “We could deploy much more capital than we currently have,” says Florian. “We believe there’s space for more players – although certain pockets will inevitably attract increased competition.”

“Relative to global GDP, emerging markets are still significantly under-allocated in many portfolios.”

The greatest constraint, however, isn’t deal flow – it’s institutional investors’ willingness to allocate to emerging markets. “Large institutional investors that are willing to invest in infrastructure often won’t touch emerging markets, not even in the public space,” he notes. “Relative to global GDP, emerging markets are still significantly under-allocated in many portfolios.” While in Europe the private credit opportunity set is mature, crowded, and capital-rich – “with too many funds chasing the same opportunities,” Florian believes some of that competition-heavy capital could be more efficiently deployed in emerging markets – benefiting both local businesses and global portfolios.

This article features in the “2025 Private Markets” publication.