In addition to the structural growth premium, EMs often have some exposure to long-term secular themes within a region, such as the  demographic dividend in Africa or the growth of e-commerce and  technology manufacturing in parts of Asia. These secular themes  should provide attractive, long-term growth opportunities for  specific companies.

Lastly, in EMs, there is growth in public markets, where informal  capital markets become formal and mature, leading to improved  corporate governance and access to higher-quality assets at  potentially more attractive valuations.

Since the 1990s, EMs have become a standard theme in global investment portfolios, albeit still relatively small. However, the  experience over the past decade suggests that a simple passive  approach to EM investing doesn’t guarantee higher returns, despite  what the structural growth premiums and secular trends would  suggest and despite what are often seen as attractive valuations.

The experience over the past decade suggests that a simple passive approach  to EM investing doesn’t guarantee higher returns, despite what the  structural growth premiums and secular trends would suggest and despite what  are often seen as attractive valuations.

The equity returns of EMs as a collective asset class have been  disappointing over the past decade. Reasons are plentiful, such  as political and policy uncertainty in EMs and slower commodity  demand growth, especially from China. However, a dollar-bull  market that started in 2012 made investments in local currency  EM assets less attractive, especially for dollar-based investors.

the early 2000s before the global financial crisis.

One could argue that DM equity returns are skewed to the upside  by the US, but even European equities outperformed, with an  annualized total return of 6.3 percent in US dollars. Furthermore,  the returns generated in EM were more volatile than those of DM  and the European market.

However, EM is not a homogenous group of countries that provide similar returns, and these markets differ significantly. When  considering individual EM economies, it becomes apparent that  there is a broad dispersion of returns. Once again, over the past  ten years up until the end of the first quarter of 2025, according to  Bloomberg, the MSCI Taiwan Index had an annualized total return  of 12.5 percent in US dollars, while India returned 8.1 percent,  Brazil returned 4.1 percent, China returned 2.7 percent, and Mexico  returned 1.5 percent. 

There needs to be a selective bias in EM, just as in DM. This is even  more the case, given that the volatility, or standard deviation of  returns, in the MSCI EM Index has consistently been higher than in DM.

Arguably, after the experience since 2009, only when risk is managed adequately can structural trends still be the source of potential  higher returns.

The stylized risks to consider in EM
Investments worldwide tend to face the same types of risks.  However, in EM, many risks that carry less weight in DM tend to  be highly pronounced and are often more challenging to quantify.  These risks are part of why EMs tends to appear cheaper on a  price-to-earnings-ratio (P/E) multiple than DMs. For example, over  the past ten years, the MSCI EM Index traded at an average P/E  ratio of 13.7x compared to the DM Index at 18.5x. The opposite also  holds: if risks can be managed, assets can be purchased at lower  valuations. These risks that would need more attention can broadly  be grouped into five buckets:

EM risks may be complex, but they can also be mitigated through a well-structured framework. Often, five key considerations can go a  long way to address the risks.

1. Local knowledge and research: Information flow in EMs tends to be less than in DMs and is often asymmetric due to market inefficiencies, policy uncertainty, and political influences. As a result, local context is often a key advantage that enables investors to benefit through bottom-up analysis and on-the-ground research teams, which usually generate significant informational advantages.
2. Regional and country diversification: EMs are not homogeneous, so excessive diversification can lead to inferior performance, as historical returns suggest. But diversification across regions, such as Southeast Asia or Eastern Europe, can also mitigate region-specific risks. Within areas, further limits on individual country exposure could be implemented. This diversification framework can also address sectoral diversification to mitigate cyclical and structural risks.

   When it comes to EM local markets, the challenge is not just directional risk, but also tail events—such as sudden stops, currency devaluations, or capital flight episodes.
   

3. Local vs. hard currency debt allocation: Slightly away from equities, but when it comes to EM fixed income markets, an important choice is whether to invest in local or hard currency debt. Local currency debt instruments offer higher yields and potential for currency appreciation but at greater FX risk. Hard-currency debt (e.g., sovereign or corporate USD bonds) is typically less volatile but subject to dollar liquidity in the domestic market and is also more correlated with US rates and global credit markets.
4. Governance screening: Screening for governance quality at the government and company levels is critical in equity and credit markets.

   Underlying risks must be managed, and investment should be made accordingly
   

5. Scenario planning: Although long-term structural themes often exist within EM economies, these themes unfold within a cyclical global economy. Incorporating risk models and stress testing for themes such as US dollar strength or commodity price shocks can support cyclical hedging or rebalancing decisions.