On a recent trip to Australia, I found the discussions and questions from the wholesale (adviser) market were grounded in problems to be solved and opportunities to be captured. It became clear that they are very much focused on investing with an absolute return mindset, rather than seeking to take excessive risk. They are looking for opportunities to compound capital over time and go where the opportunities are; but also, where people feel comfortable. It is a practical, common sense, long-term approach to investing.
So given this, I was struck that, while advisers are laser-focused on protecting clients’ capital, the same focus does not always apply when looking at how portfolios might differ from benchmarks. In fact, there is a view among some that it is ‘safer’ to be close to the index.
That said, there is clearly some worry about large exposures to the US. If you invest passively or in many global equity funds, you know you may have over two-thirds of your money going to the US. And I did sense more people are beginning to question if that is still appropriate.
It is increasingly acknowledged that the US political situation has changed, and the world is moving towards greater protectionism and mercantilism, which is likely to create an environment that is very different to what most of us have experienced in previous decades.
But the biggest risk is that investment strategies are still mostly structured as if nothing is really changing. And investors’ continued expectations are, largely, that US markets will enjoy ongoing success. But will the next 15 years repeat the last 15?
What are the emerging risks?
Many developed countries are funding large budget deficits with borrowing. High debt levels may eventually drive long-term interest rates higher (or impact the value of their currencies) potentially causing lower asset prices. Yet price/earnings (P/E) ratios for companies in these markets are near record-highs. This is a contradiction, and something has got to give; either interest rates or P/E ratios need to come down.
There are also question marks about the impact of speculative short-term trading; liquidity is plentiful, and animal spirits are running high, driving bubbles in certain areas of the market. Moreover, allocations to private equity and private credit are at record levels, leading to a more challenging risk/reward equation moving forward.
Individually these risks – all of which are more prevalent in developed markets - are potentially manageable, but in a recession or market stress scenario, it is likely they would be correlated and combine to form a serious challenge for investors.
Interestingly, just as we are seeing these risks emerging in developed markets, we are seeing stronger investment opportunities start to develop across emerging markets.
Are emerging markets staging a comeback?
This year for the first time in a long time, emerging markets have outperformed the US with a one-year return of 21 per cent, much of this performance has surprisingly occurred since the US’ ‘Liberation Day’ tariff announcement on 2 April 2025.
In addition to geopolitical shifts, we believe there have been two intrinsic drivers for this outperformance. One is the enhancements made by Korea to its corporate governance framework. The other is a move by Chinese investors away from property and savings into equities.
On a cyclically adjusted basis, US shares on average trade at 34 times earnings, a near-record. In contrast, shares in emerging markets trade at a 60% discount. Investors may have largely missed this as many do not look beyond the benchmark index and/or do not look too closely at valuations.
While they may have been long overlooked and underweight in many portfolios, emerging markets have outperformed world markets since inception of its benchmark in 1988. However, over the last 15 years they have underperformed the US significantly as investors focused on the rise of the headline grabbing mega-cap growth stocks, well-illustrated by the rise of the so-called ‘Magnificent Seven’.
Yet during this same period, emerging market countries have been transforming and becoming more self-reliant and more central to global growth. Many have also become more fiscally disciplined, in several cases surpassing their developed market peers.
Despite these gradual changes, investors continue to be concerned about geopolitical risk associated with these countries. The constantly evolving backdrop of global macro and geopolitical events mean these types of risks present challenges for all markets. For example, Taiwan manufactures a dominant portion of the world’s most advanced semiconductor chips, so any disruption there would likely impact the Magnificent Seven stocks negatively. However, such risks do not seem to be priced into these stocks.
Many developed countries, including the US, are seeking to re-industrialise and onshore manufacturing to reduce exposure to geopolitical risk. But many aspects of globalisation, such as the setup of existing supply chains into Asia and other emerging markets, are likely irreversible. While these reshoring moves may reduce some geopolitical risk, they are also likely to be less profitable for participants. China and other emerging markets are extremely competitive in many industries, and this fact is sometimes not fully appreciated in the West.
One country that may be the exception to this is Australia. With its geographic proximity to Asia and its close trading ties, it appears to have a more nuanced view about the opportunities in China, India, and Southeast Asia. Many Australians know Asia well, which offers these investors an opportunity to uncover great prospects in markets that are situated on their doorstep.
Going back to basics
Broader emerging markets exposure, for example through passive index exposure, captures a better diversification benefit with less valuation risk. But, as with developed market indices, emerging markets indices are similarly concentrated. China and Taiwan make up over 50% of the MSCI EM Index, of which 11% is in a single stock.
Twenty years ago, when I went to company meetings, there would be a lot more overall interest in long-term analysis and in deeply understanding businesses. However, with the rise of indexing, the investors taking this type of bottom-up approach are increasingly few and far between. There are generally fewer people investing with a long-term view, supported by a physical presence in markets that allows for in-person meetings with company management, competitors, customers, and suppliers.
If you are truly interested in investing for the long-term, then you are in effect a co-owner of these businesses. This means dealing with people, not just data.
As bottom-up investors, our process involves in-depth research and analysis, including having an on-the-ground research presence in Hong Kong. By focusing on business fundamentals, we identify and invest in many solid, owner-manager led companies, run by people of high integrity. In our view, these businesses are operating as strongly as successful entrepreneurial businesses anywhere in the world.
A passive approach misses the alpha opportunity in emerging markets. For disciplined investors, these markets are rich hunting ground for uncovering mispriced long-term investment opportunities.
Lack of familiarity may be causing investors to make incorrect assumptions and perceive them to be riskier than our experience suggests they are. With valuations becoming more compelling, and real risks appearing to emerge in developed markets, we believe now ought to be the time for investors to start reconsidering their views.
From a diversification standpoint we would encourage investors to look deeper into emerging markets with the mindset that they could be an opportunity rather than a risk. Correlations with world markets have fallen, offering real diversification when it is needed most. Selective ownership of high-quality emerging market businesses trading on low valuations run by able and aligned owner-management with integrity could help improve portfolio resilience and potential long-term returns.
Stefan Magnusson is the manager of the Orbis Emerging Markets Equity Strategy and is based in Hong Kong.
