Why Emerging Market Equities now?

2025 was a great year for emerging market (EM) equities; they delivered their best returns since 2017, and were ahead of developed market (DM) stocks by around 10%. Amid geopolitical and economic turbulence, this outperformance has demonstrated the inherent resilience and improving fundamentals of the asset class. 

Investors are beginning to notice. After being overlooked for several years, interest in emerging markets (EM) is increasing, particularly as confidence in US exceptionalism has been shaken. 

We asked Michael Bourke, Head of Emerging Market Equities at M&G Investments, to share his thoughts on what’s driving EM performance, improving corporate behaviour, where he sees promising opportunities, and whether it could be time for EM to return to the spotlight. 

Q. EM equities delivered their best performance since 2017 in 2025. What were the key drivers of the rally?

The gains in EM have been driven by a variety of factors – the weakness of the US dollar, excitement about artificial intelligence (AI) and easing US-China tensions. EM stocks have participated in the AI boom: the release of China’s DeepSeek model fuelled excitement about China’s AI progress, while companies in Korea and Taiwan are producing the memory chips that are powering the AI revolution. 

In certain markets, notably Korea, China and Mexico, a significant proportion of the returns is accounted for by valuation, that is the markets have become more expensive. This has been driven by optimism about future earnings, which we believe we’ll see in the coming year.

Overall, the EM rally is a story of expanding valuations that are well supported by forward-looking earnings estimates, in our view. 

Q. Looking ahead, could EM continue to perform well in 2026?

We think 2026 could be another positive year for EM. The macroeconomic environment looks supportive for company earnings: EM continue to offer superior economic growth to DM and are in better financial health than DM, which are struggling with higher debts and fiscal balances. This backdrop could be favourable for companies and earnings are expected to be a key driver of performance with consensus estimates forecasting 17% and 12% growth in 2026 and 2027, respectively.

The market is expecting interest rates cuts by the Federal Reserve in the coming year, which would give more flexibility to EM central banks – higher US rates typically reduce the attractiveness of EM assets. We could see further monetary easing in EM, which could potentially support economic activity. And finally, we may see a structurally weaker US dollar as “less-exceptional” macroeconomic and market performance in the US erodes the dollar’s still rich valuation. 

Q. EM equities have been out of favour for several years. Could this be the start of a new era? 

It is true that EM performance has been poor for a decade, both in absolute terms and relative to DM. This rally only brings the market back to where it was in early 2021. So, even though performance has been strong, we feel more optimistic about EM’s longer-term prospects than we have for a while.

Historically, we’ve seen EM performance relative to DM move in cycles with growth differentials often being a key driver of outperformance. We think conditions are potentially developing for better EM relative returns in the next decade.

For a start, we see very high valuations on the US side and much better valuation positioning on the EM side. As well as valuations, we believe the earnings picture is more encouraging. One of the reasons for the past decade of underperformance is poor earnings growth. The good news is that conditions are starting to shift as corporates, particularly in China, are becoming better capital allocators.

The level of returns being delivered by EM firms in the past couple of years has climbed to the peaks delivered over the last decade. In our view, this trend is actually well supported. Earnings estimates for EM over the next 10 years point to improving growth differentials which supports potential outperformance vs DM over the long term.

The higher returns are being reflected in a higher valuation. The market now trades on price-to-earnings ratio of 14 times, which is above the average of the last decade. But we believe this is warranted by the higher levels of corporate profitability. 

Q. China is the dominant market in EM. What trends are you seeing here?

Investors have been wary of China for some time – until fairly recently it was being described as “uninvestable”. But animal spirits are recovering in China; there has been a record amount of investment from mainland China into Hong Kong in 2025 and overseas investors have also returned to China. 

The appeal of Chinese AI stocks and new issuance have attracted capital. In addition, interest rates in China are very low – around 1% - which has also encouraged savers to put their money into the equity markets.  

One of investors’ main concerns about China has been the prolonged real estate crisis. An oversupply of property and falling prices have had a negative wealth effect but we feel the housing downturn has reached a bottom. Housing starts have fallen, which is helping to reduce inventory levels and leading to an overall improvement in economic activity.

China’s priorities in its next five-year plan are interesting. Policymakers are beginning to focus on higher quality growth and there’s talk about greater self-reliance in technology, which relates to semiconductor and AI-related equipment.

We think the technology sector is very exciting. DeepSeek revealed China’s AI capabilities. Interestingly, China is going down the road of open-source AI models, which could lead to wider use and adoption. It could also mean that the economic benefits may accrue more to the application developers rather than the model builders, a notable point of differentiation with AI in the West.

In terms of corporate behaviour, we are optimistic about better capital allocation and the potential for higher returns in China. We believe China has adopted some of the shareholder friendly measures we've seen in other Asian markets, such as share buybacks across both state and private companies and higher dividends.

Q. Many investors have low allocations to EM in their portfolios. What are the main characteristics of EM equities and how can they enhance portfolios? 

Investors are generally under-allocated to EM, largely because of the dominance of the US. For a start, many active global funds have a lower allocation to EM than the c.11% weighting in the MSCI ACWI Index¹. Moreover, that index weighting does not fully reflect the economic importance of EM, which is now around 50% of global GDP. As a result, investors are both cyclically and structurally underweight EM, and therefore potentially missing out on many promising opportunities. 

We think the most compelling aspects of the asset class are its resilience and diversification benefits. Recently, the regional diversification of EM has proved beneficial, with different regions performing well at different times: market leadership has rotated from EM Europe to Korea and Latin America and then to China and South Africa, helping it outpace DM equities. 

The wide sector mix in EM also contributes to its inherent resilience – the asset class spans commodities, technology, financials, manufacturing and services. This means that no single macro factor, be it domestic consumption, export demand or reforms, dominates returns. 

In EM, correlations between and across countries and sectors diverge, offering opportunities to diversify risk exposure. EM equities have low correlation with developed markets, which can also reduce portfolio risk. As investors look to diversify away from the US and market concentration, EM equities could potentially enhance portfolio resilience and investment returns.

Q. Where do you see value and promising opportunities currently? 

We are bottom-up stock pickers and our investments are the result of finding attractively valued stock-specific opportunities rather than views on countries and sectors. Nevertheless, we currently have some meaningful allocations to certain countries, where we are seeing more promising opportunities. 

For instance, we think valuations in Brazil are attractive and many stocks remain cheap relative to fundamentals. Domestic conditions are also improving as monetary policy eases. 

Indonesia is another market where we have been increasing our weighting lately. We are finding more ideas with upside potential in comparison to North Asia. Valuations look attractive, while underlying profitability still looks sustainable, in our view. 

We think there is room for South Africa to continue to surprise investors. We see many candidates for improving returns and attractive valuations. The country’s power shortages have eased which could aid economic growth and be good for corporate earnings.

Q. What is distinctive about your approach to EM investing? 

First and foremost, we are active investors. We have the freedom to go anywhere in the EM universe to find value. Given the divergence between valuations and profitability that can often be found across EM, having the flexibility to move capital around, take advantage of dislocation and find opportunities across different markets can be very helpful.

We are also long term, which enables us to benefit from the volatility that is a hallmark of the asset class. EM equities have a tendency to overreact to external shocks and these volatility swings provide an opportunity for us as long-term investors to take advantage of short-term irrational moments.

Since 2009, we have followed a consistent and repeatable investment process that incorporates three core tenets: return on capital, valuations and shareholder alignment. Essentially, we focus on finding companies that can improve or sustain their return on capital, where their future returns are being undervalued, and whose interests are aligned with their shareholders. 

A distinctive feature that we think is well suited to the volatile nature of EM investing is our focus on building a balanced portfolio. We invest in four distinct types of companies with different characteristics, which is designed to deliver consistent performance in different market conditions.

As disciplined investors with a long-term horizon, we believe that our bottom-up valuation-focused strategy is a differentiated approach to EM investing that can successfully capture the diverse long-term opportunities the asset class has to offer.
 

¹ Polen Capital, ‘Emerging Markets: A rare window of opportunity’, (polencapital.com), August 2023.