Emerging market equities and debt have outperformed their developed market counterparts this year, driven by structural shifts favoring these regions. Overall, emerging market countries have experienced lower inflation, appreciating currencies, and benefited from both a weaker U.S. dollar and earlier domestic interest rate easing cycles—well ahead of many developed markets.
As of the end of September, the MSCI Emerging Markets Index, which tracks large- and mid-cap stocks across 24 emerging market countries, is up 29.8% year to date. In comparison, the S&P 500 has risen about 14.65%, and the STOXX Europe 600 has increased approximately 11.9% over the same period.
“EM has been outperforming this year—finally, right? Because it’s been a very long winter,” says Guilherme Riveiro do Valle, founding partner and portfolio manager at ABS Global Investments. He notes that since 2009, the emerging markets trade has not performed well—until now. “Most of the money has been concentrated in developed markets, especially in the U.S., and for good reason. The main driver was very loose monetary policies across the U.S., Europe, and Japan, providing a lot of liquidity. That didn’t happen across most emerging markets—not because they didn’t want to, but because they could not.”
### Emerging Markets in a Stronger Cyclical Position
A June report from asset manager Robeco highlighted that emerging markets are now in a cyclically strong position, having recovered from post-COVID defaults—a challenge still facing developed market credit. In fixed income, emerging market corporates have outperformed U.S. high-yield and global investment grade credit, according to Robeco.
Eastspring Investments also noted that emerging markets hard currency yields have remained above historical averages, offering more attractive yields than other global fixed-income segments. The firm predicts that emerging market spreads will remain relatively stable due to a resilient economic outlook.
Despite their recent outperformance, emerging market equities are relatively cheap, trading at about 14 times forward earnings—roughly 30% cheaper than developed market equities and 42% cheaper than U.S. equities. “In aggregate, you see emerging markets still trading around or below 15 times earnings, with similar or even higher earnings growth compared to the U.S.,” do Valle explains. “You still see very attractive valuations when compared to countries like the U.S., with comparable or higher growth but much lower valuations.”
### A Growing Opportunity for Diversification
As investors increasingly diversify globally, emerging markets present an under-appreciated opportunity. Hayley Tran, managing principal and head of equities research at Meketa Investment Group, remarks, “With growing discussion around the end of prolonged dollar strength and the beginning of a weaker dollar cycle, we see potential for a significant boost to EM assets. EM equities have historically offered both diversification and the potential for enhanced returns.”
### The Resurgence of Emerging Markets Fixed Income
Emerging markets’ fixed income is also experiencing a resurgence—especially in hard and local currency debt, as well as investment grade corporates. This is partly fueled by rising commodity prices, EM credit rating upgrades, increased inflows, and a declining U.S. dollar, according to Vontobel strategist and portfolio manager Carlos de Sousa.
Mark McKeown, managing principal and head of fixed income research at Meketa, notes that many EM debt investors are now positioning for a weaker dollar, which bodes well for emerging markets and non-dollar assets. Rising commodity prices provide additional tailwinds, as many emerging markets are significant producers.
“For fixed income, it’s not about growth—it’s about the ability to repay debts,” de Sousa says. “In this context, having lower levels of industrialization and more exposure to commodity exports is a plus.”
At least eight emerging market countries have seen credit rating upgrades in 2025, while developed market sovereigns have experienced more downgrades than usual—a rare development, de Sousa adds. “For nearly a decade since mid-2014, emerging markets faced more rating downgrades. Since the second half of 2023, we’ve seen the opposite.”
Vontobel’s September report noted that in the prior three months, EM sovereigns saw “11 upgrades and two downgrades—the highest net upgrades in more than a decade.”
### Increased Inflows into EM Fixed Income
Allocators have increased investments in EM fixed income this year after years of outflows. “Since May, we have observed sustained inflows into the asset class,” de Sousa says.
EM investment grade companies have also outperformed their U.S. counterparts. Over the past decade, EM investment grade debt returned an annualized 3.3%, edging out the 3.1% return of U.S. investment grade corporate debt, with lower volatility (4.1% vs. 6.7%).
Ella Hoxha, head of fixed income at BNY Mellon’s Newton Investments, notes that many developed markets, including the U.S., face challenges like high deficits and weakening currencies. “The only area not experiencing these problems is many emerging markets, which exhibit high real rates, falling inflation, and central banks engaging in a positive dynamic with appreciating currencies,” she says.
McKeown adds that inflation is moderating across emerging markets, indicating potential for further rate cuts. Many EM countries began their interest rate easing cycles before the U.S. and other developed countries did.
“EM debt fundamentals are strong, with real yields at 20-year highs and spreads compelling compared to U.S. high-yield bonds,” McKeown notes.
### Navigating Emerging Market Risks
Emerging markets have long been viewed as riskier due to political instability, volatility, and occasionally weaker corporate governance. However, de Sousa points out that “while still perceived as riskier, emerging market investment grade performance closely mirrors that of developed market investment grade, often delivering slightly higher total returns with lower volatility.”
McKeown highlights that uncertainty around U.S. trade policy, geopolitical risks, and rising U.S. deficits increase risk in developed markets, potentially driving investors to demand higher yields from U.S. fixed income.
Currency dynamics have historically played a significant role in emerging market returns. For U.S.-based investors, the dollar’s strength or weakness has major implications. “Perhaps the types of risks previously viewed as ‘emerging market risks’—like government intervention—can now be argued to exist in the U.S. as well,” do Valle comments.
### Diversification Benefits of Emerging Markets
Another compelling reason to invest in emerging markets is diversification. “Emerging markets encompass almost 80 countries, enabling investors to build highly diversified portfolios,” de Sousa explains. In contrast, developed markets have fewer countries and greater concentration risks.
Do Valle adds that emerging markets are not a monolith. “Each country has its own political and economic cycle, companies, sectors, and themes. Investing broadly across emerging markets provides diverse exposure managed prudently.”
Robeco’s report underscores this diversity: India and Southeast Asian nations benefit from strong domestic demand and digitalization, while Latin America, a more cyclical region, offers exposure to commodities and attractive real yields.
### Growing Institutional Interest in Emerging Markets
Asset owners are increasingly warming up to EM investments. However, do Valle notes that institutional investors are often “rejigging” their existing EM allocations by replacing managers rather than significantly increasing exposure.
“After many years of pullbacks by U.S. institutional investors, we’re seeing increased flows into emerging market debt, driven by expectations of a weakening U.S. dollar,” says McKeown. Notably, U.S. institutional clients are exploring local currency EM debt for the first time in years, diversifying beyond hard currency debt.
Many institutional investors prefer active management and blended strategies when investing in EM fixed income. “Blended approaches that include sovereign and corporate bonds in U.S. dollars, euros, and local currencies allow managers to mitigate country, credit, and currency risks through naive hedging,” McKeown explains.
Tran points out that EM allocations are typically considered within the broader portfolio context and aligned with overall risk-return goals. “Active strategies can introduce additional volatility, which influences sizing decisions. Ongoing rebalancing helps maintain alignment with targets.”
Emerging market assets usually serve as a building block for durable, long-term investment outcomes rather than a tactical bet, Tran adds.
### Emerging Markets Allocations Remain Modest
Despite growing interest, EM assets remain a relatively small portion of institutional portfolios. Many portfolios with EM investments hold single-digit allocations to emerging market equity and fixed income.
“For much of the last 15 years, the ‘long winter’ period for emerging markets, many consultants recommended overweight EM allocations that ultimately were not profitable,” do Valle explains. “As a result, some asset owners remain cautious.”
An August white paper from State Street reported that the share of high yield and emerging market debt increased to 2.5% of investment portfolios in 2023 from 1.4% in 2020. The paper noted that “the gap in expected returns between HY/EMD and public equities is narrowing, leading to competition for capital, though the small size of the HY/EMD market naturally limits this.”
Dan Morgan, multi-asset analyst at Ninety One UK Ltd., believes investor comfort with EM is growing slowly: “It takes time for clients to gain confidence investing in emerging markets, but it feels like we are entering that stage now.”
—
### Related Stories
– *Voya Fixed-Income CIO Tips Treasury Duration, Emerging Market Assets as Offsets*
– *Investors Eye Emerging Markets for Some Relative Quiet*
– *Emerging Market Bonds, on a Roll, Should Do Even Better, Says Ned Davis*
—
Emerging markets offer attractive valuations, growing economic resilience, and diversification benefits. As structural shifts continue to favor these economies, both equity and fixed income segments stand poised for sustained investor interest in the years ahead.
https://www.ai-cio.com/news/after-very-long-winter-emerging-markets-may-finally-be-living-up-to-their-potential/?utm_source=rss-feed&utm_medium=news&utm_campaign=feed
