GBI-EM Local Bond Index Mechanics

The EMBI tracks emerging market government bonds issued in U.S. dollars. J.P. Morgan's GBI-EM (Government Bond Index-Emerging Markets) does the analogous job for bonds issued in each country's own local currency, a Mexican government bond paying in pesos, a South African bond paying in rand. That single difference changes what an investor is actually exposed to in a fundamental way.

Local currency changes what you're actually holding

A dollar-denominated EM bond's return to a U.S. investor comes almost entirely from yield and credit spread changes, since the payments are already in dollars. A local-currency bond's return comes from three sources layered together: the bond's own yield, changes in the local bond's price (as local interest rates move), and, often the largest and most volatile piece, changes in the exchange rate between that local currency and the dollar. A bond yielding an attractive 9% in local currency terms can still produce a negative return for a dollar-based investor if that currency depreciates by more than 9% against the dollar over the holding period.

This is precisely why local-currency EM debt is considered a different, often more volatile asset class than dollar-denominated EM debt, even when the same country and similar maturities are involved, the currency component can dominate the total return, for better or worse, in a way dollar bonds are constructed specifically to avoid.

How the index handles this

Like the EMBI, the GBI-EM comes in a diversified version that caps individual country weights to avoid a few large, liquid local bond markets dominating the whole index. Because not every country's local bond market is accessible to foreign investors, some restrict foreign ownership or make repatriating proceeds difficult, inclusion in the GBI-EM itself functions as a marker of a country's local market being sufficiently open, similar in spirit to the accessibility criteria index providers use for equities.

What this means in practice

An investor choosing between EMBI-tracking (dollar) and GBI-EM-tracking (local currency) exposure is really choosing whether they want pure credit risk or credit risk bundled with currency risk, and many EM debt allocations deliberately blend both, since the two respond differently to global conditions: dollar strength tends to hurt local-currency EM debt through the currency leg specifically, independent of any change in the underlying countries' creditworthiness.