Insight The strategic role of EM equities

Emerging market equities have been popular since the 1980s and optimal allocations based on data since 1999 suggest an important role within global multi-asset portfolios. However, the nature of EM indices has changed, and post-Covid returns were disappointing (though with a recent upturn). Nevertheless, our forward looking analysis based on Invesco CMAs supports the conclusion that EM equities can play a strategic role. From a cyclical perspective, we think the global economy could strengthen in 2027 (if energy prices weaken), which history suggests could support EM equities.

Main conclusions: 

▪ Emerging market (EM) equities have provided strong returns over the period since 1999 and would play an important role in optimal allocations based on that data (especially at the higher volatility end of the efficient frontier).

▪ However, performance in the immediate post-Covid years was disappointing. Despite the recent improvement, an optimisation analysis based on the last 10 years suggests no strategic role. Further, the nature of EM indices has changed, with greater concentration and a heavier weighting in technology.

▪ On the positive side, EM equities are now relatively attractive compared to US and global indices, which was not the case 10-20 years ago. Indeed, Invesco’s 10-year CMA projections suggest that EM equity returns will be relatively attractive over the next decade (see Figure 1). Optimisations based on those CMAs suggest that EM equities could play an important role within global multi-asset portfolios, confirming the earlier conclusion derived from longer data histories.

▪ Correlation analysis suggests that EM equities have outperformed when cyclical indicators such as the US ISM Manufacturing index, the G20 leading index and commodity prices are improving (especially for EMEA, Lat Am and ex-China EM regions). On top of our strategic preference for EM equities, our view that the global economy could strengthen in 2027 also leads us to a tactical preference.

Introduction 

Emerging market (EM) equities has been a popular asset class since at least the 1980s. Common arguments in its favour are often centred on the possibility of higher returns than on other assets, including developed market equities, and diversification benefits. However, the asset class has gone through big changes over recent decades, including the emergence of China as a large part of any emerging market index and the more recent concentration in technology stocks. It also feels as though it is harder to gain diversification benefits than used to be the case. Is there still a case to be made for EM equities as a separate asset category (distinct from global equities), and, if so, how has its role evolved?

Figure 2 shows the results of a simple analysis based on data since 1999 that puts EM equities into a global multi-asset framework. A quick glance at Figure 2a suggests that EM equity returns have been higher than for the other assets in the study. That is encouraging, but those returns came with higher volatility and with elevated correlation to other assets (the size of the bubbles is in proportion to the average pairwise correlation with other assets). Hence, it is likely that EM equities would have played an important role in optimal portfolios (especially given that the asset class is on the efficient frontier), despite high volatility and correlation. 

Figure 2b confirms just that, though the exercise was unconstrained and therefore impractical for investors that impose diversification. EM equities dominate optimal allocations at the more volatile end of the efficient frontier but are not present in the low-to-mid volatility ranges. Cash, which is close to the other end of the efficient frontier, dominates allocations in the lower volatility areas, while gold dominates the mid-volatility segments (it is very close to the efficient frontier). 

That is all well and good, but a lot has changed 1999. Leaving aside EM equities for the moment, gold has gone from extreme lows to extreme highs (in real terms) and it will be interesting to see if it plays the same dominant role when different periods are used. China has emerged as the world’s second largest economy and is now challenging the US, while India has more recently emerged as an economic force. At the same time, the world is going through a demographic deceleration, and some of the important members of EM equity indices are at the forefront of that (China and South Korea, for example). Finally, the composition of EM equity indices has changed massively, and it is not clear that the asset class still behaves the same way. All of this will be the subject matter of the coming sections. 

EM equities in a state of flux 

The economies of emerging countries have become more important within the global economy over recent decades (see Figure 3), with the gains due partly to a rising share of world population but mainly to a closure of GDP per capita gaps. Based on IMF data, EM economies had gone from 35% of the global economy in 1980 to 61% by 2025. The growth of the Chinese economy accounts for a large part of that, going from 2.1% to 19.6%, while India’s economy went from 2.7% to 8.2%. The share of other emerging economies has been relatively stable, moving from 30.2% to 32.7%. Among developed economies, the share of the US within the global economy has fallen from 21.6% to 14.6%, while the share of other advanced economies has fallen from 43.4% to 24.8%. 

At the same time, emerging market equities have become more important within global markets (see Figure 4). Starting at 6.8% in January 1995, the share of emerging markets within global market capitalisation had risen to 22.5% by September 2026 (with a peak at 28.5% in January 2021, as the popularity of Chinese stocks peaked). That is based on MSCI indices, but our own calculations based on broader World Bank data, gives similar results, with the share of equity market capitalisation accounted for by low and middle income countries rising from 6.3% in 2003 to 23.3% by 2025 (China’s share went from 1.6% to 11.0% and India’s from 1.0% to 7.5%). 

Just as emerging economies and stock markets have played a more important role within the global economy and global markets, the composition of emerging market indices has changed, suggesting that what investors own when they invest in emerging markets has evolved.

Focusing on the MSCI Emerging Markets Index, even the last 20 years has seen important changes in composition. For example, on 31 August 2006, the five largest national components of the MSCI Emerging Markets Index were South Korea (19.1%), Taiwan (13.8%), Brazil (11.5%), China (9.0%) and South Africa (8.9%). That suggests a mix of manufacturing and commodities were dominant. 

By 31 August 2026, the five largest markets were Taiwan (27.5%), South Korea (20.8%), China (16.9%), India (11.2%) and Brazil (3.9%). That suggests the index has become more concentrated, with the top five markets now accounting for more than 80% of the index versus 62% in 2006. Based on those country weighting changes, commodity producers now seem less important than they were, and technology seems to have become more important. 

Indeed, Figure 5 shows how the technology sector has become more important, accounting for 41.6% of the index on 31 August 2026, versus less than 12% in August 2011 (a time when financials, materials and energy were the dominant sectors, with commodity related sectors benefitting from the commodity super-cycle of the first decade of this century). Financials remain important (20.7% of the index, as of 31 August 2026) but most other sectors have been squeezed by technology (commodity related sectors also suffered from the weakness of commodity prices as the super-cycle deflated). 

Hence, investing in emerging markets seems like a different proposition today than it was 20 or 30 years ago. In recent years, EM ex-China indices have become popular, ostensibly to reduce the dominance of China within portfolios (China accounted for 30% of the MSCI EM index at the end of 2020). The logic being that the Chinese market was so big, that it merited separate consideration. Perhaps the same logic could apply today to the technology sector. Although the dominance of technology stocks may render EM investing more compelling to many investors, it could also make EM indices less useful as diversifiers versus the US market, say. 

Given the changing nature of emerging indices, it may be worth considering the use of data from shorter periods to test whether the conclusions shown in Figure 2 remain valid. This will be covered in the next section. 

Recent history is less supportive of EM equities 

Figure 6a suggests that if we focus on the last 10 years, the performance of global assets is similar to that of the original period since 1999, in that EM equities have been more volatile than most other assets. However, despite the higher volatility, EM equity returns have been lower than for both gold and MSCI World. 

Figure 6a splits the EM equity performance into MSCI China and MSCI EM ex-China, since the poor performance of Chinese equities was an important factor in depressing MSCI EM returns over 10 years (China was 21% of the MSCI EM index at end-August 2016). But, as can be seen, even MSCI EM ex-China returns were marginally lower than those of MSCI World and gold.

Figure 6b shows that this translates into there being no role for either MSCI China or MSCI EM ex-China within optimal allocations along the efficient frontier. Those optimal allocations are split between MSCI World, gold, commodities and cash (again the exercise was unconstrained and therefore impractical for investors that impose diversification). 

It may seem odd that commodities (CTY) play a role in the optimal allocations despite generating lower returns than MSCI EM ex-China, with higher volatility. The answer to that conundrum is that commodities offered better diversification possibilities (lower correlation to other assets), as indicated by the small bubble. The same is also true for cash and gold. On the other hand, MSCI EM ex-China offered no particular advantage as a diversifier. MSCI China appears to have been a better diversifier, but the low returns count against it. 

So, does that imply we should ignore EM equities within global multi-asset portfolios? If we expect the last 10 years to be a guide to future asset returns, the answer would be yes. However, we think there are reasons to doubt the returns shown in Figure 6a will be repeated: first, the low fixed income returns were the result of a normalisation of yields that we think were artificially depressed 10 years ago (by central bank QE policies); second, we doubt that gold returns will continue to be so impressive (starting at a very low point in real terms at the turn of the century, gold’s recent performance has exceeded long term returns); finally, just as Chinese equity returns have been depressed over the last 10 years, US equity returns have been exceptional and we expect a reversal of that comparison (based on valuations). Indeed, EM equity relative returns have improved since early 2025. 

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.