Massimiliano Castelli Philipp Salman

In 2013, when the Federal Reserve (Fed) announced the tapering of its quantitative easing and treasury yields surged, emerging market (EM) assets were heavily impacted as investors feared that the end of the unorthodox monetary policies would trigger a massive sell-off in global markets. In 2022, when advanced economies started raising interest rates to fight the surge in inflation, there was fear that emerging markets would face a similar fate with macroeconomic and financial instability.

These expectations proved wrong. While some EMs were heavily impacted, most navigated the interest rate hiking cycle better than expected. They started raising rates earlier than advanced economies to defend their currencies and fight inflation and did not let their domestic and foreign debt levels rise to unsustainable levels. This “preventive” macroeconomic management paid off and many EMs have already succeeded in bringing inflation under control. Some have already started loosening monetary policy and their currencies have gained against the USD and other advanced economies (e.g., Brazil).

The negative expectations about EMs’ ability to deal with higher interest rates were also fueled by China’s challenges. China’s lower-than-expected recovery following the lifting of Covid-related restrictions coupled with ongoing geopolitical tensions with the US further dampened the appetite of investors for EM assets.

We argue that investors should reconsider their allocation to emerging markets, considering these assets remain large underweight in global portfolios. The case for EMs rests on the positive growth differential with advanced economies – still intact despite the lower-than-expected growth in China – and long-term structural trends such as demographics, the rise of the middle class, and urbanization. The slowdown in globalization and international corporations’ diversification away from China have also opened up some new opportunities for other EMs, for instance Mexico and Vietnam.

In this paper we look at the “case for emerging markets”. First, we look at macroeconomics, which comprises solid macroeconomic fundamentals and better creditworthiness thanks to better macroeconomic management and low debt levels. Then we review the asset allocation case: a higher exposure to emerging markets’ assets, in line with their increased weight in the global economy, can improve the risk-adjusted returns of a global balanced portfolio. And finally, we elaborate on the market case: emerging markets’ valuations look attractive when compared to advanced economies and long-term investors should take advantage of these opportunities to increase their exposure to these economies which are and will likely remain the growth motor of the global economy.

S-04/24 NAMT-1014

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