Why Emerging markets?
Key takeaways
Emerging markets (EM) equities remain reasonably valued, and dispersion in valuation between markets presents good opportunities for active stock pickers.
We believe fears around deglobalisation are overstated, as many developing countries are involved in the reconfiguration of global trade.
EM equities have demonstrated resilience in the current market environment, benefiting from improving shareholder returns and healthy corporate balance sheets.
Why ignoring emerging markets might be risky?
Often viewed through the lens of volatility and political uncertainty, emerging markets (EM) can seem like an unpredictable ride. Recent volatility linked to increased trade tensions between the U.S. and its global trading partners, lingering economic uncertainty in China, and higher interest rates in the U.S. have exacerbated concerns about these markets. After many years of ‘US exceptionalism’ drawing in investor capital, and talk of deglobalisation on the rise, it’s no wonder investors are cautious.
Yet, avoiding EM entirely could pose an even greater risk. As renowned investor John Templeton said, “Bull markets are born on pessimism, they grow on scepticism, they mature on optimism, and they die on euphoria.” For active investors, lingering scepticism around many emerging markets and the valuation dispersion within may in fact present a strong entry point.
Challenging conventional wisdom when thinking about EM
The idea that emerging markets are simply “too risky” in the current uncertain environment overlooks the multifaceted nature of global trade, economic dynamics, and asset valuation. Over time, equity markets worldwide tend to deliver broadly similar annualized returns, with periods of outperformance and underperformance. We strongly believe that starting valuations matter to subsequent returns. Furthermore, what feels uncomfortable at any given time may prove to be profitable thanks to the equity risk premium on offer for bearing this emotion.
Today, investor exposure and the market-cap concentration in U.S. equities reflects past performance and presents risks, especially for passive investors. U.S. companies now represent over 70% of global equity indices, while emerging markets account for only 10%1. Given that 85% of the world’s population resides in emerging countries and contributes to half of global growth2, this underrepresentation at the market level likely means that opportunities are being overlooked.
Valuations further support the case for investing in emerging markets. The MSCI Emerging Markets Index3 currently trades at a forward price-to-earnings ratio of 12.8x, a significant discount to the MSCI World Index4. While it’s important not to treat these markets as a monolith, some of the disparities are striking—for instance, close to 80% of Indian stocks trade above a forward P/E of 20x, a real outlier compared to other EM and its own history5.
Opportunities within the framework of deglobalisation
Despite widespread concerns about deglobalisation, its impact on global trade has been much less impactful than feared as trade routes have adapted through intermediary countries and production has shifted to so-called ‘friendly’ regions. Intra-regional trade among emerging markets has also flourished, growing to $4.5 trillion by the end of 2023—an 80% increase since 20166. Countries like India and Indonesia are benefiting from urbanisation and demographic growth, while Latin American nations play a critical role in the renewable energy transition. Additionally, emerging economies in Eastern Europe and Mexico are gaining market share as decentralised supply chains evolve. Rather than collapsing, global trade is indeed reconfiguring, with emerging markets leading the way in a new phase of re-globalisation evidenced by increases in intra-Asia and intra-EM trade.
Resilience in times of volatility
Recent volatility in global markets has tested the resilience of emerging market assets, and the results are encouraging. The last twelve months have seen bouts of volatility amidst concerns over U.S. protectionism and related recession risks, with currency fluctuations leading to a sell-off in risk assets. However, emerging markets currencies have generally strengthened to the US dollar, and their equity markets have held their ground7.
While this reflects growing concern over the direction of policy under the current US administration, and hints at the end of ‘US exceptionalism’, it also points to strong fundamentals in emerging markets. With no signs of economic overheating and currencies trading at attractive levels, EM assets appear well-positioned as ever to weather future market shocks. Moreover, undervalued and under-owned assets tend to be less vulnerable to periods of market stress, and healthy corporate balance sheets offer fundamental support, giving global investors another reason to reconsider emerging markets.
A valuation discount with upside potential
Earnings from EM companies currently trade at a 45% discount to those of U.S. companies, reflecting lingering investor scepticism8. However, the earnings growth outlook for emerging markets over the next three years is bright9. While we would argue that these consensus expectations are verging on the optimistic, if US-dollar denominated earnings per share growth in emerging markets is no longer inferior to the US market, supported by a less buoyant US-dollar, past performance may not be a good guide to the future.
In addition to earnings growth, EM companies are increasingly adopting shareholder-friendly practices, such as share buybacks and dividend payments. Markets are rewarding these positive developments with higher valuations, as seen in the price recoveries of specific companies in Korea and China. This focus on shareholder returns, combined with strong corporate balance sheets, enhances the appeal of emerging markets.
The missed opportunity of ignoring emerging markets
Emerging markets are far from a monolithic story. While uncertainties remain, the diverse nature of these economies offers a range of opportunities, from demographic-driven growth in India and Indonesia to supply chain benefits in Asia and Latin America. Current valuations, earnings potential, and recent resilience in volatile markets all suggest that these markets deserve serious consideration.
For investors, the real risk may not lie in the volatility of these markets, but in the opportunity cost of staying on the sidelines. As companies across emerging regions continue to adapt and grow, they offer a valuable source of diversification and the potential for long-term returns—making them a compelling addition to a global portfolio.
