Emerging market (EM) equities are set for another leg of outperformance, according to Michael Tambue, investment specialist at TT International.

Below, he explains why the asset class still has upside potential, some of the risks investors need to consider, and where TT International sees opportunities for active investors.

Are EM equities still attractive today?

We are constructive on the outlook for EM equities. Earnings momentum is improving across much of the asset class and, importantly, the breadth of revisions is broadening beyond a narrow group of large-cap index constituents. Despite recent strong gains, EM equities continue to offer a significant discount to their developed market counterparts. On forward earnings, EM trades at 11.8x, versus 18.3x for developed markets and 19.5x for the S&P 500, while price-to-book and other valuation measures also screen well. The depth of these discounts is attractive, particularly given the improvement in EM earnings dynamics. Moreover, ownership levels remain low, offering scope for higher allocations from investors.

What do you think is most underappreciated by investors and why?

Investors generally think of EM fundamentals and political risk dynamics as being somehow inferior to those in developed markets (DM), as evidenced by the higher risk premium they demand for owning EM assets. We could challenge this consensus. Compared to the developed world, EM generates stronger economic growth, and has more policy flexibility to augment such growth as inflation is already lower and falling more sharply, whilst fiscal and current-account positions are healthier. The average government debt/GDP ratio in EM is just 64%, versus 117% in DM. Similarly, corporate leverage is lower in EM than in the US, challenging the view that EM balance sheets are inherently riskier. DM macro fundamentals now increasingly resemble those of EM in the past, whilst governance risk is clearly growing in the US.

What are some risks to the thesis in EM equities?

The main risk to the thesis for EM equities would be a significantly stronger dollar. Although perhaps less of a headwind than it was in the past, this would still likely weigh on the asset class. Whilst recent geopolitical events have seen the dollar strengthen in recent weeks, we believe this will be temporary as the US continues to face structural fiscal pressures, and Trump’s erratic style of leadership is undermining investor trust. The war in Iran has increased the chance of an inflationary shock to the global economy. An environment of higher inflation and lower growth, coupled with monetary tightening in response to higher prices, would be negative for risk assets, including EM. This is not our base case, but the probability of such a scenario has increased in recent weeks. However, the aforementioned valuation support, favourable macro fundamentals and positive earnings backdrop could help to limit the damage in such an event.

What are some pitfalls in EM equities and why do investors need to be active?

Whereas active managers can struggle in more efficient DM public equities, it is a very different story in EM. Over the past 20 years, a passive EM allocation has ranked, on average, in the third quartile relative to eVestment’s EM equity active manager universe. EM equities are not a homogenous bloc. Economies are at different stages in their cycles, policy frameworks continue to diverge, and geopolitical dynamics are polarising outcomes across markets. Broad, passive exposure often fails to capture the dispersion within emerging markets, and can overweight legacy state-owned sectors or geopolitically sensitive areas. We are moving into a multi-polar world characterised by elevated volatility. Against this backdrop, stock-level dispersion in EM is increasing, and is near its highest level in at least the past 20 years. A truly active approach that integrates macroeconomic and company analysis to focus exposure on the most promising parts of the market over time is key.

Where do you see the best opportunities currently in the asset class? 

We are constructive on Latin America, where several economies stand to benefit from firmer commodity prices. Brazil and Argentina are key examples as they tend to see improved terms of trade when energy and broader commodity prices strengthen. Another significant exposure is gold. Our view has been that the rally in gold in recent years has been driven less by geopolitics and more by structural factors, particularly concerns around dollar debasement and sustained central bank buying. We believe these structural factors remain firmly in place. Finally, we retain exposure to the AI value chain. AI infrastructure investment, supported by strong hyperscaler cash flows, continues to drive capex across the semiconductor supply chain, with valuation discipline becoming increasingly important as dispersion widens.