27 February 2026
For much of the past decade, the global investment narrative has been dominated by the stellar performance of Developed Markets (DM), particularly the United States. Driven by a powerful technology sector and a strengthening dollar, US equities have offered investors exceptional returns, often leaving Emerging Markets (EM) in their shadow.
However, investment landscapes are rarely static. In 2025, Emerging Markets (EM) posted their strongest outperformance against Developed Markets (DM) in 17 years, with the MSCI EM Index surging 33.6% compared to the MSCI World’s 21.1%. As we look ahead, a convergence of fundamental strengths and new structural catalysts suggests the pendulum may be swinging back in favour of Emerging Markets. For investors seeking true portfolio diversification and future growth potential, a re-examination of the EM asset class is not just warranted, it is essential.
The fundamental foundation for Emerging Market outperformance
The core case for investing in emerging markets rests on a foundation of superior long-term growth potential compared to the more mature, slower-growing developed economies. Several key pillars support this view:
- Superior economic growth: Emerging and developing economies continue to be the engine room of global growth. While developed nations face structural headwinds like aging populations, many emerging economies are in a phase of rapid industrialisation, urbanisation, and consumer class expansion. The International Monetary Fund (IMF) consistently projects a significant growth premium for emerging economies over their advanced counterparts.
- Stronger fiscal balance sheets: In a world saturated with sovereign debt, many emerging markets stand out for their relative fiscal prudence. Having learned painful lessons from past crises, many EM governments have built significant reserves and managed their debt levels more conservatively. As shown below, the disparity in debt burdens is stark.
Table 1: The Global Debt Divide
This lower debt burden provides EM governments with greater fiscal flexibility to support their economies during downturns without inciting panic in bond markets.
- Favourable demographics: Unlike the aging populations of Japan, Europe, and parts of the US, many emerging nations boast young, growing workforces. This demographic dividend translates into a larger pool of labour, rising domestic consumption, and a lower dependency ratio, all powerful drivers of long-term economic vitality.
- Independent and orthodox monetary policy: Gone are the days when EM central banks simply followed the Federal Reserve. In the recent post-pandemic inflation cycle, many EM central banks, such as those in South Africa, Brazil and Mexico, acted swiftly and proactively to raise interest rates ahead of their DM peers. This established significant credibility and has allowed them to begin easing policy sooner, providing a tailwind for their equity and bond markets.
- Attractive valuations and yields: After years of underperformance, emerging market equities currently trade at a significant valuation discount to developed markets, particularly US large-caps. Furthermore, EM bonds, both sovereign and corporate, often offer considerably higher yields, providing an attractive income stream for investors in a world where yield is still relatively scarce.
What is different this time? New catalysts for a multi-year rally
While the fundamental arguments have existed for some time, a new set of distinct catalysts are emerging that could unlock this value and drive substantial outperformance in the coming years.
1. A weaker US dollar environment:
The strength of the US dollar over the last decade has been a major headwind for emerging markets. A strong dollar increases debt servicing costs for dollar-denominated EM debt and makes their less attractive to foreign investors. High US interest rates and a strong dollar have sucked in global capital. However, since the Federal Reserve started cutting interest rates and uncertainties arose in the US economy, the outlook for the dollar has turned bearish. A weakening dollar acts as a powerful stimulant for EMs, easing financial conditions, boosting commodity prices in local terms, and encouraging capital inflows.
The chart illustrates a generally inverse (negative) correlation between the two metrics over the past three decades. From 1993 to 1999, Emerging Markets lagged Developed Markets, largely due to severe financial crises, the strengthening of the US dollar leading to capital outflows, and the impact of the 1997 Asian financial crisis. Between 2010 and 2024, factors contributing to the continued underperformance of Emerging Markets included the US Zero Interest Rate Policy and ongoing dollar strength, which prompted further capital flows from Emerging Markets to Developed Markets, primarily to the US. Recently, this trend has shifted, and Emerging Markets have regained favour.
2. The artificial intelligence leapfrog:
Far from being left behind, emerging markets are uniquely positioned to benefit from the AI revolution. Across Asia, Africa, and Latin America, countries are adopting AI solutions in agriculture, manufacturing, healthcare, and fintech to "leapfrog" traditional stages of development, leading to massive productivity gains. The integration of AI is creating new, high-growth investable opportunities within EM economies that go beyond traditional sectors. By leveraging high-efficiency architectures and a strategic focus on open-source models, China has significantly lowered the cost of AI development, with firms like DeepSeek offering high-performance reasoning models at a significant discount compared to Western proprietary alternatives. This "low-cost, high-scale" approach allows Asian industries to rapidly integrate AI into manufacturing and logistics, "leapfrogging" traditional development hurdles to drive massive productivity gains across the region.
3. Corporate governance reforms and shareholder focus:
A quiet revolution is underway in corporate governance across key emerging markets. From South Korea's "Corporate Value-Up" program to regulatory pushes in China and Brazil, there is a concerted effort to improve transparency, boost dividend payouts, and align management interests with those of minority shareholders. These reforms are making EM equities more investable and could lead to a significant upward re-rating of valuations as global investors recognise this positive structural shift.
4. Deglobalisation and new strategic alliances:
As the world moves away from a unipolar globalisation model towards a more fragmented one characterised by tariffs and "friend-shoring," many emerging markets are adapting by forging new regional and bilateral trade deals. This realignment allows countries to diversify their supply chains and reduce reliance on any single trading partner, creating new centres of economic activity and resilience independent of the traditional West-led order. This is shown for example by Canada’s trade deals with China, dubbed the EVs-for-Canola swap, which focusses on Canada’s electric vehicle push and provides agricultural products to China. India has signed deals with the UK, South Korea, Canada and Brazil, reducing reliance on the United States.
5. Supportive commodity prices and global risk appetite:
Many emerging markets are major exporters of essential commodities, from industrial metals needed for the green energy transition to energy and agriculture, as well as value storing metals like Gold. A supportive long-term outlook for commodity prices provides a natural hedge and an economic boost for these nations. Furthermore, as investors grow wary of high valuations in US tech, global risk appetite is increasingly seeking out the better value and growth prospects offered by emerging markets.
The imperative for diversification
For investors, the message is clear: a portfolio heavily skewed towards US and developed market equities presents portfolio concentration risk in what has worked in the past, not necessarily what will work in the future. Focus should be on gradual diversification rather than fully moving from DM to EM.
For many years, a standard portfolio might have been 100% concentrated in Developed Markets to chase the US tech rally or US exceptionalism. However, in today’s environment, shifting just 10% of that exposure into Emerging Markets can significantly enhance a portfolio’s risk-adjusted returns without upending a client's risk profile.
Diversification is the only free lunch in investing. By including a meaningful allocation to emerging markets, investors can:
- Access unique return drivers that are less correlated with developed markets.
- Tap into higher potential economic growth regions of the world.
- Benefit from much more attractive entry valuations.
- Reduce possible losses linked to overpriced developed market equities, especially areas of overenthusiasm like US technology stocks.
While emerging markets undoubtedly carry higher volatility and distinct risks, their current combination of strong fundamentals, attractive valuations, and powerful new tailwinds presents a compelling opportunity. Ignoring this asset class risks missing out on what could be the next great rotation in global markets.
