Are emerging markets the next big opportunity or a potential pitfall? As we approach the new year, investors are faced with a crucial decision: should they embrace the risks and rewards of these markets or steer clear? The answer, it seems, lies in the eye of the beholder, and the potential for both success and failure is what makes this a compelling yet controversial topic. But here's where it gets interesting...
Emerging markets have had a tumultuous start to the year, with a sharp sell-off in the spring due to uncertainty surrounding US trade policies. However, they have since rebounded strongly, reinforcing the belief that these markets offer some of the most attractive long-term opportunities. At the heart of this argument is valuation. Stefan Magnusson, head of emerging markets investing at Orbis Investments, highlights a crucial point: investors' reluctance to return to emerging markets stems from a misplaced faith in backward-looking risk measures.
"Traditional risk measures don't paint a pretty picture for emerging markets," he says. "Over the past 15 years, returns have severely lagged their developed-market peers and have also been more volatile. For a rational investor with a reasonable level of risk aversion, emerging markets have been an uncomfortable place to invest."
This discomfort has driven investors towards the perceived safety of the US market, which provides a smoother ride when viewed through the lens of backward-looking risk measures. However, Magnusson argues that at today's prices, the deeper risk may lie in avoiding emerging markets rather than owning them.
On a cyclically adjusted basis, US equities trade at nearly 38x earnings, near record levels, while emerging markets trade at around 16x, below their long-term average and at a significant discount of roughly 60%. "When US shares have been valued at this multiple historically, they reliably returned just low single-digits nominally over the next decade," Magnusson notes. Emerging markets, by contrast, offer a much wider range of outcomes that "skew more positively," with forward returns historically ranging from low single digits to more than 15% per annum.
These starting points are crucial because they shape long-term outcomes far more reliably than near-term macroeconomic forecasts. Political instability, governance weaknesses, and currency volatility in emerging markets are real, but "these risks are visible and, in many cases, already reflected in depressed prices," Magnusson says. In contrast, ballooning fiscal deficits, trade policy uncertainty, and concentration risk in the US "appear to have had little to no impact on valuations."
Magnusson advocates for broad emerging market exposure for diversification reasons but cautions against assuming passive allocations solve the problem. China and Taiwan account for more than half of the MSCI Emerging Markets index, with around 11% in a single stock: TSMC. "A passive approach misses the exceptional alpha opportunity in emerging markets," he says, arguing that limited analyst coverage, inefficiencies, and a higher proportion of long-term compounders create fertile ground for active managers willing to be selective.
John Citron, manager of the JPMorgan Emerging Markets Growth & Income fund, agrees that the underlying investment case in emerging markets is strengthening. "There are clear signs that the tide is turning," he says, pointing to firmer earnings expectations and other macro trends such as a weaker US dollar and improving domestic demand. This year's rebound was supported by dollar weakness and a rotation away from the US, alongside improving sentiment in China as authorities moved to bolster consumer confidence and stabilize the property sector.
Technology has been central to that recovery, particularly the role emerging markets play in the global artificial-intelligence (AI) supply chain. Citron describes this as a defining theme, adding that the AI revolution remains in its early stages. Taiwan and Korea, he says, continue to play critical roles as suppliers of memory chips, advanced processors, and data-center hardware, with companies such as SK Hynix and TSMC already benefiting from accelerating demand.
Alongside technology, Citron says China's policy shift has been key. Authorities' efforts to stabilize the property sector and support consumers have helped sentiment, while US trade policy has prompted a wave of domestic investment as manufacturers seek to localize supply chains. However, not everyone within JP Morgan shares the same degree of optimism on China. Omar Negyal, portfolio manager of the JPMorgan Global Emerging Markets Income trust, warns that after the rapid recovery, "expectations may have run ahead of reality," especially in China and parts of the technology complex.
While many emerging economies are in better fiscal health than in previous cycles, geopolitics, elections, and the path of the US dollar will shape outcomes in 2026, according to the manager. Volatility, however, isn't a reason to retreat – it's "a chance to find the next wave of long-term winners," he says.
India, the other emerging-market heavyweight, has been on a disappointing path this year, as it's been left out of the AI trade. Despite this, after several strong years, it remains expensive. Magnusson warns that high-growth stories often disappoint equity investors when starting prices are elevated. "There is no reliable link between overall GDP growth and equity returns," he says, arguing that India's premium valuation leaves little margin for error. Chris Tennant, co-portfolio manager of Fidelity Emerging Markets, shares this caution, acknowledging India's strong demographic tailwinds but noting that the market is expensive and difficult for investors focused on both quality and valuation.
In global emerging markets, Tennant has become increasingly constructive on electrification, where the shift in global power generation and the build-out of renewables are driving demand for copper. "Copper supply remains constrained following a decade of underinvestment," he says, adding that this year is likely the first in which mine supply declines. He has also increased his exposure to gold, as "the historic relationship between gold and real rates has broken down," with investors and central banks turning to gold as a store of value. "Despite the price moves this year, gold miners continue to look attractively valued and generate high free cash flow," he notes, citing improved capital discipline across the sector.
In smaller emerging countries, banking sectors are often oligopolistic and generate strong returns on equity while trading near book value, the manager notes, which has resulted in "excellent value across much of the universe," particularly in central and eastern Europe. Financials and fintech companies are also attractive. With the dollar having broken its long-term uptrend, the environment increasingly favors non-US assets, according to Abdallah Guezour, head of emerging market debt and commodities at Schroders. "A recovery in portfolio flows to emerging market debt is underway," he says. Combined with abundant global liquidity, this reinforces the appeal of emerging market debt, particularly in local currency markets. Schroders continues to favor countries such as Brazil, Mexico, South Africa, India, and parts of central Europe, where valuations remain compelling and policy flexibility is high.
Despite many emerging economies entering 2026 from a position of relative strength, none of the managers denied the risks. Charles Jillings, co-portfolio manager of Utilico Emerging Markets Trust, highlighted two key threats. First, a material slowdown in global growth. "A weaker US economy would result in a fall in consumption, which would impact export-driven economies and markets, which in turn would impact commodity-driven countries due to less demand for resources," he says. The second risk is geopolitics, with a material increase in geopolitical tension potentially leading to "a sudden increase in oil prices, which would result in short-term inflationary pressures and place financial stress on energy-importing economies."
As we move forward, investors will need to carefully consider these risks and opportunities. The potential for both success and failure in emerging markets is what makes this a compelling yet controversial topic. Will you embrace the risks and rewards, or steer clear? The choice is yours, and the potential for discussion and debate is what makes investing such an exciting and dynamic field.
