Capital in transition

Financial markets have been striking in their resilience. Despite geopolitical uncertainty, shifting rate expectations and the inflationary implications of higher energy prices, risk assets have held up. US equities are close to historical highs, corporate credit spreads have widened only modestly and markets have absorbed a succession of shocks with relatively little disruption.

Investors are neither unaware of the risks nor complacent about them; portfolios are being reassessed and, in many cases, adjusted. But the willingness to maintain exposure to risk assets suggests that markets continue to place considerable weight on the strength of the underlying economic and corporate picture.

Artificial intelligence is an important factor here. Its investment cycle has provided a counterweight to geopolitical uncertainty. Earnings have been robust across many AI-exposed companies, capital expenditure remains substantial and the infrastructure build-out is creating opportunities across sectors and regions. How durable that support proves will be one of the defining questions for markets over the next 12 to 18 months.

Achieving diversification has become more complex. Correlations between US Treasuries and equities have increased, weakening the role government bonds have traditionally played as a ballast to equity risk. At the same time, equity valuations remain elevated on measures such as the Shiller cyclically adjusted price-to-earnings ratio.

These factors do not necessarily call for a wholesale reduction in strategic equity exposure. They do, however, suggest a need for greater precision in portfolio construction. Tactical adjustments, factor-based approaches and a wider range of diversifying strategies all have a role to play.

Broadening equity market performance has therefore been a welcome development. Europe, Korea, Japan and China have all produced areas of genuine strength, supported in many cases by improving fundamentals. After a prolonged period in which US mega-cap companies dominated global equity returns, investors are being presented with a richer and more varied opportunity set.

Geographical diversification is front of mind for many investors. A natural extension of that thought is ’emerging markets’ – a term often used too loosely. Risks vary significantly across equities, local currency debt and dollar-denominated bonds. In equities, a small group of countries accounts for a large share of the investable universe. Hard currency debt, by contrast, offers exposure across more than 65 countries with no single country dominating the benchmark index.

Historical performance is also noteworthy. Emerging market hard currency debt has outperformed similarly rated US credit over last few years, and EM corporate bonds have also delivered highly competitive risk-adjusted returns relative to other areas of global fixed income.¹ And yet the asset class remains underrepresented in many institutional portfolios.

Such caution is understandable, but arguably outdated; emerging markets have a long association with capital flight, currency crises and sovereign defaults. However, the underlying picture has changed considerably. Many countries have strengthened their policy frameworks, pursued fiscal discipline and taken steps to improve central bank credibility. Upgrade-to-downgrade ratios for emerging market sovereigns have been unusually strong, and there have been no sovereign defaults since the end of 2023.

Technical factors are also supportive. Supply of hard currency emerging market debt has been negative or only marginally positive for several years. Demand has begun to increase as investors reassess the geographic balance of their portfolios. Flows into emerging market debt have remained positive on a year-to-date basis, including during periods of heightened geopolitical volatility.

Fixed income conditions in general have also improved. Yields of around 5% to 6% are now available across a range of markets. Real rates are higher and the Federal Reserve appears likely to remain on hold for now. For investors seeking income and a measure of stability, the starting point is more attractive than it has been for some time.

Opportunities are far from uniform, though. Spreads in US and European investment-grade credit remain relatively tight; while in several other markets including sub-investment grade debt, overall yields appear more compelling.

At the front end of the curve, some developed economies offer opportunities because markets have priced in a meaningful degree of monetary tightening. And central banks may ultimately deliver less than investors currently expect.

Asia is another area of interest. Investment-grade and high-yield bonds in the region proved relatively resilient during recent volatility. Fundamentals remain sound, while local demand is substantial. In many cases, the limiting factor is the scarcity of supply rather than a lack of investor appetite. Australia’s emergence as a major new-issuance market is one indication of the capital seeking opportunities within the region.

No fixed income discussion can be complete without considering US Treasuries. Long-term yields have risen, driven more by real rates than by breakeven inflation. Investors appear to be demanding a higher return for holding US government debt, reflecting concerns about long-term debt sustainability as well as the near-term inflation outlook.

Given that US Treasuries sit at the center of the global financial system, a sustained increase in the risk premium attached to the world’s reserve asset would have implications across portfolios.

Unsurprisingly, AI was a recurring theme throughout the panel. Its impact is already visible in corporate earnings and infrastructure spending, with the build-out spanning semiconductors, components, energy, utilities, industrials and supply chains. Over time, the application of AI across sectors such as manufacturing and biotechnology may broaden the opportunity further.

Geographical considerations complicate the picture. With the substantial majority of global GPU capacity currently located in the US, a disproportionate share of productivity gains and economic value may well accrue to the companies and countries that control the compute. If AI development continues along its present trajectory, this concentration matters.

At the same time, however, the hardware ecosystem is global. Taiwan and Korea play a central role in the semiconductor supply chain, with many companies across Asia integral to the physical infrastructure on which the AI economy depends. Their importance may not always receive the same attention as the large US technology companies, but it is no less fundamental, and in some cases critical.

Neither assuming AI is exclusively a US story nor treating its benefits as evenly distributed is the right approach. Investors need to trace where capital is being spent, where bottlenecks are emerging and where value is likely to accrue at each stage of the supply chain.

Uncertainty is an immovable fixture of investment markets. What matters more right now is whether portfolios are designed to withstand it.

Although the traditional approach to diversification remains necessary, it is no longer sufficient on its own. Sector exposure, style factors and country and security selection all matter. As do geography, currency concentration, liquidity and the changing behavior of assets that have historically served as hedges.

Some of the most interesting opportunities are developing in areas that remain relatively underrepresented in global portfolios: emerging market hard currency debt, Asian fixed income, selected liquid alternatives and the AI supply chain beyond the US.

While markets have absorbed a remarkable amount of uncertainty, the task for allocators is to distinguish between the risks already reflected in prices and the opportunities that still sit outside the consensus.

¹Emerging markets fixed income: Past, present and future, UBS Asset Management, 11 September 2025.