Emerging markets today: from macro beta to micro alpha

Postcard

 

• Australian investors are increasingly dialled into the EM story.
• Tech, India’s rise, and China’s private sector are driving EM growth.
• While risks remain, EM equities offer value and broader alpha dispersion.
• Growing uncertainty about US growth could be a catalyst for increasing allocations to EM.

Archie Hart, Portfolio Manager

One of the privileges of my role is engaging with asset owners across the world, exchanging views on emerging markets from multiple perspectives. After 28 investor meetings across Perth, Melbourne and Sydney in just five days, it was clear that Australian investors are increasingly dialled into the emerging market (EM) story. These conversations echoed discussions we have been having globally — there’s growing debate about whether we are transitioning away from an era of US exceptionalism, bringing EM into sharper focus.

What stood out most on this trip was the shift in sentiment. Australian asset owners frequently noted that EM equity valuations already reflect the well-worn risks of investing in these markets. Some high-quality businesses are trading at just 10–15x earnings — markedly lower than the S&P 500’s current PE of around 28x — making them hard to ignore. At the same time, alpha dispersion across EM equity managers is widening, sparking deeper discussions about our investment approach and idea generation.

Here are the topics that resonated:

What’s driving EM equity returns?

A decade ago, the MSCI EM Index presented a different landscape — China, state-owned enterprises (SOEs) and old-world industries like commodities dominated. That world is gone. Today, three key engines are driving EM: China, India, and technology, with the UAE, Latin America, Eastern Europe, and Southeast Asia adding momentum.

China’s role in the index has shifted. Its weight has fallen from 39% in 2020 to 31% today, giving space for others. More importantly, its composition has changed — SOEs, once over half of China’s equity exposure, are now overshadowed by a wave of fast-growing, private-sector businesses. Allocators also took note of President Xi’s recent remarks reaffirming support for the private sector — a sign that Beijing is working to restore confidence after years of regulatory pressure.

To illustrate this, small collectible dolls from Pop Mart, a Chinese company specialising in designer toys, ‘popped’ up in our meetings. A few years ago, Pop Mart was a niche brand selling ‘blind box’ figurines to a small but devoted fan base. Today, it’s a publicly listed business with a market cap of several billion dollars, riding a wave of demand from young consumers who crave products that feel personal, collectible and tied to cultural identity. It’s the kind of company that doesn’t show up in top-down macro narratives, but it’s exactly the type of domestic-driven, consumer-facing business that’s thriving in China today.

It underlines how much China’s equity landscape has evolved. This is no longer just a play on big banks, property developers and exporters. The real growth is coming from private enterprises that understand shifting consumer behaviour and deliver what the market wants.

India’s rise was another standout discussion. A few years ago, it was a secondary player in EM equity portfolios. Today, at nearly 20% of the index, it’s firmly established as a global economic force. Its rapid digital transformation — driven by digital identity adoption and financial services — is reshaping consumer behaviour and unlocking growth. Foreign capital is pouring in, and India’s stock market now ranks among the world’s top five.

India’s expansion and the UAE’s growth show a similar upward trajectory. Interestingly the UAE is evolving into India’s financial hub — much like Hong Kong was for China. With business-friendly regulations and a focus on digital infrastructure, the UAE has become a gateway for capital. Trade between the two has surged, making the UAE India’s third-largest trading partner. This trend is evident in real estate and banking, where companies like Emaar Properties and Abu Dhabi Commercial Bank are benefitting from this cross-border dynamism.

And then there’s technology. Emerging markets are the world’s AI factory. The US might lead on intellectual property, but the hardware — the chips, cloud servers and devices — is built in EM. Taiwan and South Korea dominate semiconductors, putting EM at the centre of the AI revolution.

Will Trump’s tariffs hurt EM?

This was the most asked question: Will Trump’s trade policies derail the EM story? The reality is more nuanced than the headlines suggest. Since the odds of Trump’s re-election started rising, China and the broader EM universe have outperformed the US and the ‘Magnificent 7’.

We expect the volatility to continue. The way forward is to identify businesses with natural hedges — companies resilient to geopolitical and economic shocks. A great example is Arca Continental, a leading Coca-Cola bottler in Mexico. With a third of its revenue from the US, it’s well-insulated from Mexico-specific risks, and its diversified network adds resilience.

China, often in the tariff crosshairs, has reduced its reliance on the US. Back in 2016, 22% of its exports went to the US. Today? Just 13%. At the same time, China has built deeper trade relationships, filling gaps left by the US retreating from involvement in a number of global trade agreements.

We’ve focused on businesses that sidestep tariff risks — consumer staples, healthcare, and technology services with strong local demand. This aligns with Beijing’s push for self-sufficiency. In times of heightened geopolitical risks, we find more pricing anomalies while short-term investors react to the headlines.

What other risks are on the horizon?

Beyond trade tensions, the US dollar remains a key risk. A strong dollar tightens financial conditions, making dollar debt more expensive and pressuring local currencies. While dollar momentum has eased, sticky inflation complicates the outlook.

The Federal Reserve (Fed) is expected to cut rates this year, which should provide relief. But the labour market remains a wildcard — rising unemployment would signal weakness, while wage pressures could keep inflation high. If the Fed keeps rates elevated, the dollar could strengthen again, creating a headwind for EM.

Still, EM equities don’t need a weaker dollar to perform — they just need it to stop rising at breakneck speed.

Another structural risk? The fragmentation of global capital markets. If US-China tensions escalate, restrictions on US investment in Chinese firms could disrupt capital flows, heightening volatility. But even in a fractured global market, EM remains primed for stock-pickers. With 1,300 stocks in the EM universe, investors don’t need to make broad macro bets — they just need to find high-quality companies.

The EM outlook: cautiously optimistic

Global growth is holding up, with the IMF projecting a 3.3% expansion in 2025, and EM economies growing at 4%+, led by India and Southeast Asia.

Developed market interest rates are heading lower. The European Central Bank has already started cutting, and the Fed is expected to follow. Historically, a mix of falling rates, a stabilising dollar, and easing geopolitical risks has provided a strong tailwind for EM equities.

Most investors have relatively low allocations to emerging markets, reflecting the challenges the asset class has faced over the past decade. Our view is that we may be nearing the end of this difficult period. The US has rarely been this expensive, and EM equities have rarely been this cheap. With growing uncertainty around US growth, my takeaway from investor discussions is that this could be a catalyst for increasing allocations to EM equities.

Download PDF