Emerging Markets Have Changed. Should Allocations Follow?

Emerging markets (EM) allocations are likely too low due to outdated perceptions, despite improving fundamentals and diverse growth drivers. EM equities represent just 5.6% of global assets, well below their 20-year average, and EM debt has seen significant outflows. This outdated positioning persists because investors are still scarred by past crises and associate EM with commodities and volatility, rather than today's innovation and domestic consumption.

The current EM opportunity set is fundamentally different. Fiscal positions are improving in many EM countries while deteriorating in developed markets, and the EM-DM growth gap is widening in EM's favor. EM central banks have shown greater policy credibility, and corporate balance sheets are stronger. While geopolitical risk, inflation, and dollar strength remain concerns, the composition of risk has shifted.

For portfolios, this suggests revisiting EM allocations may be less about adding risk and more about correcting obsolete assumptions. The asset class now offers diversification benefits and compelling growth opportunities, particularly in technology and domestic consumption, which are increasingly found outside the US. Careful security selection and a decision on hard versus local currency debt are critical given tight sovereign spreads.