Emerging markets: Rebalancing portfolios could lead to significant performance gains

• Ernest Yeung
  Portfolio Manager Emerging Markets Discovery Equity Strategy
  T. Rowe Price

Many global portfolios remain 7–8% underweight, so there is room for significant inflows if the momentum continues. Even a partial rebalancing could lead to significant performance gains.

Despite the dominant headlines, the actual impact on EM economies is often overestimated due to fears surrounding tariffs and geopolitics. Vietnam and the Philippines, for example, are considered trade-dependent, but their growth is largely driven by domestic consumption. Chinese exporters have adapted quickly by rerouting their supply chains and maintaining their export volumes. Conclusion: Short-term volatility may increase, but the long-term trend remains intact.

Currency markets offer additional tailwinds. Historically, emerging market assets have outperformed during periods of US dollar weakness. With economists forecasting a multi-year soft dollar cycle, emerging markets could be entering a new phase of strength. Developed markets such as Europe and Japan have already responded; emerging markets are not until catching up.

Valuations add to the appeal. Emerging market equities posted earnings growth of over 20% last year, yet trade at significantly lower price-to-earnings ratios than the S&P 500. For investors wary of excessive valuations in developed markets, emerging markets offer higher growth at lower prices.

Not if, but how

The real challenge is not whether to invest in emerging markets, but how. Most EM funds focus on a handful of mega-cap companies such as Tencent, TSMC, Samsung and Alibaba. These are solid companies, but they are widely held and offer limited alpha. Our strategy takes a contrarian approach. It targets the “forgotten middle” – average companies that are overlooked by mainstream investors but have clear catalysts for change.

This strategy is supported by one of the industry’s largest EM research platforms, with analysts in Asia, Latin America and emerging Europe. Thanks to in-depth local knowledge and a willingness to deviate from the consensus, the team can uncover inefficiencies that others miss.

The case for emerging markets today rests on four pillars: persistent underweighting, attractive valuations, diversification benefits and frequent catalysts for change. Emerging markets are developing faster than developed markets politically, economically and entrepreneurially, offering more opportunities for active investors.

Emerging markets have not failed. They are undervalued, understaffed and underestimated. For investors willing to look beyond the obvious, emerging markets offer a compelling opportunity to rediscover growth, value and resilience.