Emerging markets

Emerging market volatility shifts lower

After a lacklustre decade of returns in emerging market equities, reviewing the structural potential for the asset class drove many allocation discussions throughout 2023. But the diversifying potential of EM equities proved a sticking point. Three main objections are often raised and this analysis reviews each in turn.

25 Jan 2024

15 minutes

Daniel Morgan
Sahil Mahtani


There is an abiding perception of undue risk in EM equity investing which has, quantifiably, become a misconception.

The reality is that EM equities are now less volatile than developed market equities. This gives renewed impetus to the case for emerging markets as a diversifying exposure which can deliver attractive risk-adjusted returns.

The term ‘emerging markets’ was coined by IFC economist Antoine van Agtmael in 1981. Since then, key drivers for these markets have centred on two factors: the potential for higher returns driven by superior economic growth and the potential for risk reduction through diversification.

For more than a decade, the performance of EM equities has fallen short of investor expectations. Ninety One's paper ‘In the Crossfire’ analysed the root causes behind a disappointing decade and re-examined the structural proposition for EM equity allocations.

Following publication, it became clear that diversification remained a point of scrutiny. Many investors lack conviction in the diversification properties of EM equities.

This led us to investigate whether stocks in developing countries really do have the potential to diversify returns and reduce risk in a global investment portfolio.

Arguments against tend to centre around the these three perceptions:

  1. “Diversification is about reducing risk; yet EMs are inherently risky.”
  2. “EM equities have not worked as a diversifier.”
  3. “In a crisis, everything sells off. EMs do not help your portfolios diversify.”

We use these refrains to structure this analysis. The results are provocative for asset owners. EM characteristics include a lower beta to DM equities outside of crises, lower volatility in recent years and lower correlations with DM equities than most asset classes of similar size.


Diversification is about reducing risk; yet EMs are inherently risky
EM equities have not worked as a diversifier
In a crisis everything sells off. EM will not save you.

Diversification is about reducing risk; yet EMs are inherently risky

Many investors highlight the perceived higher risk associated with EM equities compared to DM assets. Within portfolios, investors point out that even during challenging periods in DM economies, like the global financial crisis (GFC) in 2008, EM markets experienced more significant declines.

During crises, the volatility or risk associated with EM equities tends to be higher than that of developed market equities, probably because of the interaction between financial crises and economic crises in EMs. When risk aversion sets in, the dollar tends to appreciate, leading to capital flight from EMs. This supports the notion that EM equities inherently carry more risk compared to their DM counterparts. Meanwhile, there is always one crisis or conflict brewing in the developing world, the headlines are rarely positive.

Yet the reality is more complex than the perception of risk. By some measures, EM equity assets have become less risky than DM assets, and the notion that EM equities are little more than a leveraged bet on the most cyclical parts of the global economy is now out of date.

Start by comparing the beta of EM equities to DM equities. Examining on rolling 3-year time frame, the beta of the MSCI Emerging Markets index to its developed market counterpart has consistently remained below one throughout almost the entire history of the index. It is only during the period that includes the GFC that the sensitivity of EM equity returns to DM equity markets clearly exceeded one. One way of understanding this chart is that under normal conditions, EMs tend to be less risky than people think. However, during significant crises, the potential losses in EM can be greater.

Figure 1: Emerging market vs. developed market beta

Figure 1: Emerging market vs. developed market beta

Source: Bloomberg, MSCI where EM is represented by MSCI Emerging Markets and DM by MSCI World. Calculations by Ninety One, as at 31 December 2023.

In addition, the standalone risk profile of EM equities has changed dramatically. As emerging economies and financial markets have matured, the volatility of their equity markets have shown a steady decline. In fact, in recent years, EM equity volatility has fallen consistently and is now lower than that of developed markets.1

Figure 2: Emerging market vs. developed market volatility

Figure 2: Emerging market vs. developed market volatility

Source: Bloomberg, MSCI where EM is represented by MSCI Emerging Markets (Local) and DM by MSCI World (Local). Calculations by Ninety One, as at 31 December 2023.

EM and DM: The preconditions of growing convergence

How did we reach this remarkable situation where EM assets are now less risky by some measures than DM assets? Broadly, two things happened. EM economies have moved closer to DM in terms of governance and frameworks, while DM economies have moved slightly closer to EM economies in terms of their unpredictability and volatility.

In terms of EM improvement, by now it is well known that substantial progress has been made across macroeconomic and corporate fundamentals and market structure in emerging markets—one reason why emerging markets outperformed during the period of monetary tightening that began in late 2021.

Specifically, emerging economies have in past years worked to mitigate external vulnerabilities, improve institutional frameworks and build fiscal sustainability. At the corporate level, this has been accompanied by a push for higher standards of operating performance and corporate governance which have helped to drive the rise of companies based in emerging markets which are global leaders in their industries. There has been notable broadening and deepening of liquidity alongside improvements to the infrastructure underlying capital markets. Progress has not been uniform across all countries and companies, but the cumulative impact of these reforms is undeniable.

Emerging markets outperformed during the period of monetary tightening that began in late 2021.

Second, and perhaps more controversially, a number of DM economies have demonstrated more underlying risk than investors had come to expect from DM assets. This arguably began with the GFC and continued with the eurozone sovereign debt crisis in the 2010s. That episode stemmed from a blend of inflexible fixed exchange rates and poor fiscal management within a suboptimal currency area governed by multiple decision-making jurisdictions. This led to a decline in investor confidence regarding the sovereign creditworthiness and financial stability of eurozone economies.

During the COVID storm in March 2020, global capital markets faced an extreme stress-test. Remarkably, it was developed markets that teetered closest to failure. Liquidity in the US Treasury market, the world's largest and most liquid bond market, evaporated and it took unprecedented intervention from the US Federal Reserve to stabilise the system. Assessing the volatility of equity markets during the acute period of the crisis, it was US equity markets that exhibited the most extreme fluctuations. Daily volatility for the S&P500 index over the month of March 2020 hit 102%, almost double the volatility of the MSCI EM index that month at 56%.

While no asset class is invincible, the evidence also suggests that developed markets are less of the safe haven they were once. Meanwhile, emerging markets are also not what they used to be. By embracing reform after the crises of the 1990s, the largest emerging markets have now built stronger economies and capital markets.

The largest emerging markets have now built stronger economies and capital markets.

Correlation advantage persists

Next, we can look at correlations. EMs tend to have lower correlations with other equity markets, usually ranging between 50-60%. In comparison, US and European indices show higher correlations, typically around 70-80%. Japan, like emerging markets, has also proven to be a strong diversifier, with correlation characteristics in line with emerging markets.

That matters because the risk of EM assets in a given portfolio requires making a judgment on the total portfolio. As Harry Markowitz2 showed in the 1950s, a portfolio’s risk is not solely determined by the average riskiness of its individual assets, but rather by the degree to which the returns on those assets are correlated. In other words, investors don’t need every asset in the portfolio to be lower risk to effectively mitigate the overall risk. So as a starting point, the question of EM risk should be ‘risky to whom’?

We know, for instance, that risk-adjusted returns of EM assets in euros are typically higher than those in dollars given existing correlations of EM assets to euros and dollars. Those lower correlations create the conditions for higher risk-adjusted returns in portfolios through the mechanism of rebalancing.

After examining these portfolio risk metrics, where does this leave investors trying to understand the risk of EM assets relative to DM assets? As discussed earlier, EM equities typically exhibit lower beta values, except during crises, and have seen a declining trend in volatility. Correlations are lower than equivalent assets. In essence this translates to relatively lower standard deviation of returns but with a more negatively skewed and fatter-tailed distribution compared to equities in developed markets.

In other words, in most conditions, emerging markets demonstrably have returns with less volatility when compared with developed markets. However, the tails are fatter. Returns are more likely to have more extreme events, both positive and negative, in their distribution. If the conventional wisdom is “EM is riskier than DM,” the picture is more complex. For investors, it is clear that emerging market equities have some useful diversification properties for advanced economy investors. Reputation and reality have diverged substantially, and that is where the opportunity lies.

Reputation and reality have diverged substantially, and that is where the opportunity lies.

1 This chart is calculated using local currency return across both markets. Measuring returns in a common currency such as the US dollar makes some differences to the levels of these series but all of the specific points made in the text hold in both local currency and US dollar terms.
2 Harry Markowitz was best known for his pioneering work in modern portfolio theory, studying the effects of asset risk, return, correlation and diversification on probable investment portfolio returns.


In summary, diversification serves as a powerful tool for risk reduction in investment portfolios. EMs possess attributes that make them conducive to diversification within DM portfolios. These include a lower beta to DM equities outside of crises, reduced volatility compared to DM equities in recent years, and lower correlations with DM equities than most asset classes of a similar size.

However, it’s important to note that integrating EM equities into DM portfolios requires a strong risk management framework and a keen awareness of the macro drivers of emerging markets to mitigate potential risks.

While US investors may exhibit a ‘home bias’, the potential benefits of diversification across most equity markets could outweigh any such bias.

Moreover, the underperformance of EMs over the last decade can be attributed to specific factors that are expected to evolve differently in the coming decade. It is also crucial to differentiate between diversification and hedging. Diversification aims to enhance risk-return outcomes over time, while hedging is about downside protection in a crisis. Consequently, focusing solely on short-term market sell-offs neglects the broader diversifying and risk-reducing benefits that EM equities can offer under all other market conditions.

In general, emerging market equities are not unduly risky relative to other equity investments in most scenarios. Nevertheless, special attention should be paid to their fragility during significant crises.

Indices. Indices are shown for illustrative purposes only, are unmanaged and do not take into account market conditions or the costs associated with investing. Further, the manager’s strategy may deploy investment techniques and instruments not used to generate Index performance. For this reason, the performance of the manager and the Indices are not directly comparable.
If applicable MSCI data is sourced from MSCI Inc. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

Authored by

Daniel Morgan
Analyst, Multi-Asset
Sahil Mahtani
Strategist, Investment Institute

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