In a world where traditional growth engines are slowing and valuations in developed markets appear stretched, the strategic rationale for revisiting emerging markets has never been clearer.
The case for emerging markets rests on four pillars: persistent underweighting in global portfolios, attractive valuations, diversification benefits, and frequent catalysts for change. For many institutional investors, allocations to emerging markets have shrunk dramatically over the past decade, leaving portfolios underweight by as much as 7–8 per cent. Even a modest rebalancing towards neutral weights could provide potential for improved portfolio diversification and exposure to growth, especially as emerging economies continue to expand.
Valuations may present a compelling entry point. Despite delivering robust earnings growth of over 20 per cent in the past year, emerging markets equities trade at significantly lower price-to-earnings multiples than the S&P 500. For investors wary of stretched valuations in developed markets, emerging markets have historically demonstrated higher growth at lower valuations, representing a potential opportunity in today’s global landscape.
Diversification remains another underappreciated advantage. While risks such as tariffs and geopolitics persist, many emerging markets have shown resilience. Vietnam and the Philippines, for example, are often perceived as trade-reliant, yet their growth is largely driven by domestic consumption. Chinese exporters have adapted swiftly, rerouting supply chains and maintaining export volumes despite shifting global dynamics.
The takeaway is that short-term volatility may spike, but the long-term trajectory remains intact. Currency markets also offer another tailwind: historically, emerging market assets have outperformed during periods of US dollar weakness. With economists forecasting a multi-year soft dollar cycle, emerging markets could benefit, based on these historical relationships.
Emerging markets are also characterised by frequent catalysts for change. These economies evolve rapidly, driven by shifts in policy, demographics and technology. Such transitions have the potential to reshape entire industries and open new investment avenues, creating a dynamic environment where developments may lead to revaluations and fresh growth prospects. The pace and breadth of transformation in emerging markets set them apart from more mature economies.
To capitalise on this dynamism, a thoughtful approach to investing in emerging markets often means taking a contrarian stance – one that targets the “forgotten middle”. Instead of concentrating on large, widely followed companies, this approach seeks out average-sized firms that mainstream investors tend to overlook, yet which have clear, company-specific catalysts for change. These businesses can offer distinctive opportunities for growth and revaluation, and their relative independence from broad market sentiment may help portfolios identify upside potential while managing risk.
Emerging markets may offer more than just a tactical allocation – they present a potential strategic opportunity worth thoughtful consideration in today’s evolving market environment. For investors willing to look beyond the obvious, emerging markets may offer a compelling opportunity to rediscover growth, value and resilience as global dynamics continue to shift.
Ernest Yeung, portfolio manager of the Emerging Markets Discovery Equity Strategy at T. Rowe Price.
