Emerging markets not as “tarrified"

In response to US policies, developed markets (DM) equities have experienced falls in March, while EMs have moved the other way, rallying from a January drop to be well into positive territory for the year-to-date 2025.

The rise of emerging markets

As incomes rise and urbanisation expands, the growth rate in EM is rapidly outstripping developed markets (DM).

The International Monetary Fund forecasts real GDP growth of only 1.8% in advanced economies in 2025, compared to 4.2% for emerging and developing economies.

Recently EM equities roared back into focus, buoyed by a falling US dollar corresponding to the confirmation of tariff implementation.

Many EMs are potential beneficiaries of shifting global supply chains as the US imposes tariffs. In addition, the impact of these excises has been a weakening US dollar. The weaker dollar makes it more economical for those in EMs to finance their US dollar debts, favouring EM companies and limiting the impact of those EMs subject to tariffs. 

Chart 1: Emerging market equities outperforming as the US dollar falls

Source: Morningstar Direct, 31 December 2024 to 25 March 2025. Developed markets equities is MSCI World ex Australia Index, Emerging markets equities is MSCI EM Index, US dollar index is DXY Index. Past performance is not necessarily indicative of future performance. You cannot invest directly in an index.

Additionally, as most commodities are priced in US dollars, commodity demand increases as the US dollar falls. Many EM economies export commodities and therefore benefit if the US dollar falls. The last FOMC confirmed it's unlikely the next US Federal Reserve rate move will be up, so downward pressure on the US dollar will remain.

Preparing for a trade war

Tariffs are not unique to this Trump presidency. During his previous term in office, Trump commenced a bipartisan-supported trade war with China. The immediate impact in 2018 was that emerging markets fell, but you can see that they had rallied by the time COVID hit markets. And you can see that after COVID, EM rallied as their governments and central banks supported their local economies.

Arguably, EM’s central banks handled the crisis and the resulting inflation better than developed markets’ central banks. EM central banks’ response highlights their policy independence. This independence supports the autonomy of EM economies going forward to fight tariff risks. Trump’s tariffs 2.0, while being broader in terms of the countries being targeted, are not as surprising and potentially already priced by markets.   

Chart 2: MSCI Emerging Markets Index, February 2015 to February 2025

Source: Morningstar Direct. You cannot invest directly in an index. Index returns do not include fees and costs of investing. Past performance of the index is not a reliable indicator of future performance of the index or EMKT.

In addition, many EMs have pressing domestic issues that potentially will have a bigger impact than the tariffs long term. Two of the bigger EMs are a case in point.

In China, the outcome of its government's domestic economic policy, aimed at revitalising its property market, has perhaps more impact on the nation's long-term economic recovery than the impact of tariffs, thus providing support for sustainable investment returns.

India, meanwhile, is implementing an infrastructure reform process, and its urban economy and consumer markets continue to flourish.

These two major EMs have stock markets that are skewed to domestic-oriented companies. While tariffs will impact some companies, others will thrive.

That is not to say emerging markets are immune to external developments. You can see in the chart above that sharp falls correspond to COVID and Russia’s invasion of Ukraine. The point is that after each shock, EM equities have recovered.

The fundamental case for investing in EM remains. Demographic and urbanisation trends provide supportive tailwinds for long-term growth. 87% of the world’s population is in emerging markets, and these populations are younger than developed markets. Over 75% of the world’s population aged between 15 and 24 lives in developing and emerging markets.

We have said this before, but many EMs have matured. Traditionally, the investment returns have been closely correlated to the rise and fall of commodities and global growth expectations. Over the past 20 years, this has been changing. Many of the world’s leading technology, consumer and healthcare companies are listed on emerging markets exchanges.

Emerging markets themselves are not a monolith. Many have learned from the lessons of the past, and EM governments have undertaken economic reforms and increased trading partnerships. Some of these trading blocs do not use the US dollar to trade. As a result, these economies may be able to achieve a more stable and higher level of growth in the current global environment.

Many emerging market economies are better able to implement counter-cyclical fiscal expansion to reignite domestic growth because of their growing foreign reserves, strong budgets and robust balance of payments. This helps the companies in these countries.

Should EM equities continue to rally through this Trump presidency, early 2025 may be looked back upon as a compelling entry point.

Valuations are compelling

Another case supporting EM equities is their valuations. EM equities, as represented by the MSCI Emerging Markets Index are currently trading at 37% and 49% discount on a price-to-earnings (P/E) and a price-to-book (P/B) basis to developed markets respectively. The MSCI Emerging Markets Multi-Factor Select Index (EMKT Index), offers lower valuation ratios, so it potentially represents value.

Chart 3 & 4: P/E of Developed Markets and Emerging Markets; P/B of Developed Markets and Emerging Markets

Chart 3 and 4 Source: MSCI, March 2005 to February 2025. Price/Book Ratio is the weighted average of the last closing price of portfolio security divided by the book value of the security. You cannot invest in an index. 

Not all companies in the MSCI Emerging Markets Index are desirable from an investment standpoint.

This is where being selective in emerging markets equities can come to the fore.

Investing in emerging markets is no easy feat

Selective investment in emerging markets has traditionally been the domain of expensive active managers, and returns between them vary significantly from year-to-year. This is because it is almost impossible for active managers to time factors in emerging markets.

The VanEck MSCI Multifactor Emerging Markets Equity ETF (ASX: EMKT) tracks the MSCI Emerging Markets Multi-Factor Select Index (EMKT Index) which includes companies on the basis of four factors: Value, Momentum, Low Size and Quality. The result is a portfolio that, at last rebalance, includes 209 companies diversified across 19 countries.

The four factors combined have demonstrated long term outperformance relative to the MSCI Emerging Markets Index. EMKT has outperformed since it launched on ASX in 2018. As always noting, past performance is not indicative of future performance.

EMKT’s management fee is just 0.69% p.a., the same as the equivalent EM market beta ETF, but with the potential for active-like returns.

Table 1: EMKT performance as at 27 March 2025

Source: VanEck, Morningstar Direct

^# EMKT inception date is 10 April 2018 and a copy of the factsheet is here.
Performance is calculated net of management costs, calculated daily but does not include brokerage costs or buy/sell spreads of investing in EMKT. Past performance is not a reliable indicator of future performance.
The MSCI Emerging Markets Index (“MSCI EMI”) is shown for comparison purposes as it is the widely recognised benchmark used to measure the performance of emerging markets large- and mid-cap companies, weighted by market capitalisation. EMKT’s index measures the performance of emerging markets companies selected on the basis of their exposure to value, momentum, low size and quality factors, while maintaining a total risk profile similar to that of the MSCI EMI, at rebalance. EMKT’s index has fewer companies and different country and industry allocations than MSCI EMI. Click here for more details

Key risks:

All investments carry risk. An investment in EMKT carries risks associated with ASX trading time differences, emerging markets, financial markets generally, individual company management, industry sectors, foreign currency, country or sector concentration, political, regulatory and tax risks, fund operations, liquidity and tracking an index. See the PDS for details.