AdviserVoicePAN-Tribal and Ashmore Investment Management Archives - AdviserVoice https://www.adviservoice.com.au/source/pan-tribal-and-ashmore-investment-management/ Financial planner information & financial planner education/CPD - AdviserVoice Wed, 10 Jun 2026 21:30:37 +0000 en-US hourly 1 https://wordpress.org/?v=7.0 CPD: The investment potential in emerging market equities https://www.adviservoice.com.au/2025/10/cpd-the-investment-potential-in-emerging-market-equities/ https://www.adviservoice.com.au/2025/10/cpd-the-investment-potential-in-emerging-market-equities/#respond Sun, 12 Oct 2025 20:30:40 +0000 https://www.adviservoice.com.au/?p=106930

Combining an asset ownership mindset with a systematic investment process has the potential to result in significant and sustained alpha generation and deliver positive outcomes for your clients.

Emerging markets (EM) are highly inefficient. Complicated governance structures, evolving macroeconomics and immature institutions result in elevated stock price volatility. This creates significant alpha generation opportunities, as well as challenges, for active investors in EM equity markets.

EM specialist Ashmore believes that companies with structural competitive advantages delivering growth are best placed to benefit from EM secular growth drivers, as well as being well placed to navigate economic and market drawdowns.

Furthermore, opportunities to generate alpha are amplified by the fact that EM companies are poorly researched, especially for their medium-term fundamentals. Consequently, businesses of enduring quality are often undervalued and trade at prices that fail to reflect their ability to sustain high returns over the long term.

The compounding power of quality and growth in EM

The three characteristics most important to selecting quality EM companies are:

  1. Sustained quality, companies with enduring competitive advantages
  2. Diversified growth, compounding through reinvestment
  3. Mispriced valuation, with mispriced medium-term fundamentals

The combination of these factors is best positioned to deliver a portfolio of EM equities that meets it investment objectives and investor expectations.

Sustained quality

Quality companies typically share four important characteristics.

  1. High and sustainable return on capital
    • Superior returns can be eroded by competition over time. Only a small number of companies have structural competitive advantages that can sustain high returns on capital.
    • High returns can arise for a short-term period during industry or macro upturns. However, only few companies sustain their strong returns through cycles; the path to successful investing lies in identifying them.
  1. Strong predictable cash flow generation
    • This provides the foundation for a company to be able to make the correct investment decisions over a cycle.
    • Reported earnings can be subject to accounting presentation while cash generation rarely lies and ultimately determines the value of a business.
  1. Robust balance sheet
    • This enables companies to improve their competitive position during a macro downturn. For example, they can invest in their brands, technology, distribution and growth while others are retrenching.
    • Excessive leverage can lead to large negative outcomes for equity investors and can destroy even the best business models.
  1. Skilful management and non-financial factors
    • Capital allocation provides the link between business value and shareholder value. Long-term orientated companies that understand and address material non-financial exposures to the benefit of all stakeholders can sustain and expand their competitive advantage.
    • A skilled management team can continue to reinvest cash at high rates of return and grow the underlying earnings power of a business.

Identifying structural quality attributes requires an understanding of how a company achieves its attractive economic characteristics to ensure they are sustainable. Companies with high historic returns on investment capital (ROIC) can be identified though quantitative screens. However, one of the key determinants for future returns is a qualitative assessment of whether competitive advantages can be sustained or even improved upon.

Competitive advantages are distinct characteristics that are difficult to replicate and therefore enable super normal returns to be sustained. Sources of structural advantages usually comprise one of the following:

  • Intangible assets: including intellectual property, licenses and brands.
  • Cost advantages: driven by a proprietary process, superior scale or niche positioning.
  • Network effects: a system’s value increases as the number of users expands e.g. as a social network or marketplace.
  • Switching costs: products with high benefit/cost ratios where the risk of changing provider is high.

If a company’s management team allocates capital correctly, the company’s competitive advantage can expand as the company grows which leads to the potential for strong returns. Stocks can defy market expectations for competitive advantages to erode and ROICs to reduce to industry average, thereby creating the opportunity for sustained outperformance.

This positive effect is amplified for companies at an earlier stage of developing a competitive advantage. Consequently, focusing on companies with ‘consistent’, as well as ‘improver’, ROE profiles can often be well rewarded (see figure one).

Diversified growth

There are multiple factors to consider when targeting companies with durable growth characteristics. These include:

  • Durable growth over high growth: many companies are predicted to generate high growth yet only a select few actually deliver. Consequently, identifying realistic and durable growth drivers is key, as is being selective.
  • Compounding growth through reinvestment: growth is most attractive when combined with quality as this enables a virtuous cycle whereby free cash flow can be re-invested at high rates of return. Taken in combination with a long runway for high return investment opportunities, this enables capital to be compounded over many years.

The power of compounding earnings is not perceptible in the short term. Instead, most shareholder returns are reflected via changes in earnings multiples. However, over the longer term, it is growth and compounding of cash flows and earnings that can lead to extraordinary returns.

  • Preference for diversified growth drivers: Growth drivers can include price increases, entering new markets, new product development, cost reduction and operating leverage.

Cyclical growth that is driven predominantly by economic expansion and external factors cannot be relied upon. It is uncontrolled by management and can quickly disappear so requires additional analysis.

Growth driven by market share gains, product innovation and other initiatives is more durable as it is independent of the economic climate and is inherently more controllable.

  • The perils of low growth: beyond a lack of compounding, limited growth opportunities can often be value destructive. It can lead management teams under pressure from shareholders to allocate outside their core competency.
  • Timeframe and forecast error: while long term profitability attributes are targeted, our experience has been that the value of financial forecasting and its accuracy starts to diminish after a five-year time horizon, especially during periods of heightened technology disruption.

Mispriced valuation

Valuation discipline is important, otherwise you could be paying for the next 3-5 years of shareholder returns upfront, which meaningfully limits the total returns you are likely to make.

We believe companies with high quality attributes over the near term often trade at a premium to the broader market. This reflects some expectation of short-term operational outperformance.

However, over the longer run, businesses that can sustain their quality attributes are able to exceed expectations by maintaining high levels of profitability. Stock prices typically discount high rates of return being competed away and thus systematically undervalue quality companies.

The strongest examples of quality businesses with durable growth prospects can be held over the long run, unless market expectations become excessive. However, the potential for forecast error means position sizes should always be adjusted to the upside available.

The importance of top down

EM companies lead the world in a wide range of industries, yet they sit in economies with often immature institutions. The outcome is potentially higher stock returns but also the risk of macroeconomic volatility. This is highlighted by the significant dispersion in EM between best-to-worst country performance each calendar year (figure four).

Macroeconomic factors can, therefore, be the dominant driver of returns in the short term, often via currency impact and market multiples. Over the medium term, top down can impact a company’s operating environment and growth opportunity. Consequently, we believe an explicit assessment and integration of top down in our investment approach can help sustain alpha generation over the long run.

The use of top-down factors

By way of illustration, although Ashmore’s EM equity strategy is primarily driven by bottom-up fundamental conviction, top-down analysis plays three significant roles:

  1. A risk overlay which aims to mitigate major macro headwinds.
  2. To steer the portfolio away from economies facing headwinds.
  3. An idea generation tool attracting us to positive macro trajectories.

Further, Ashmore believes it is important to generate a proprietary team top-down view to ensure its alignment and full integration into the investment process. Each quarter the team scores countries formally, framed by a Country Scorecard. This assesses nearer team leading indicators, as well as longer term structural macroeconomic drivers, including institutions/politics.

Key top-down drivers that are assessed and scored include economic activity, the monetary cycle, fiscal accounts, external accounts, private debt and politics.

Drawing on Ashmore’s macro research, country analysis is undertaken by the member of the team responsible for stock research in that geography. This serves to frame the operating environment for their company research. Consistent macro scoring principles are applied to both short- and longer-term indicators to produce an overall rating, which impacts portfolio construction.

Case study: Country score examples

China: 2023-25

Score: Headwinds

This rating reflects a combination of poor corporate and consumer confidence weighing on activity. Together with an ineffective fiscal policy response, this is leading the economy to offset real estate pressure only modestly. Policy visibility has improved, and the private sector has seen support which has improved our conviction on select stock opportunities, but Ashmore continues to cap its China overweight until there is greater clarity over tariff risk and domestic policy.

Russia: 2022

Score: Neutral to Headwinds

In Q1 2022 Ashmore had a long-standing overweight to the market and a Neutral macro rating. It was then downgraded to ‘Headwinds’ due to rising tail risks of a war with Ukraine, which led to the overweight being meaningfully reduced ahead of the invasion. Ashmore did not go to a zero weight – i.e. ‘Major headwinds’ – as the team did not expect the invasion to materialise.

South Africa: 2022-24

Score: Major Headwinds to Neutral

In Q1 2022 Ashmore changed the rating from ‘Headwinds’ to ‘Major Headwinds’. The economy had many pre-existing challenges which ranged from poor infrastructure and weak institutions to emigration of the highly educated. Ashmore downgraded the rating given lack of political reform progress and crippling electricity blackouts.

The assessment has since improved following elections in May 2024 and the establishment of a coalition that includes the more reform orientated Democratic Alliance, as well as less pressure from electricity shortages. This led to a ‘Neutral’ view. The outlook remains uncertain, though, with limited compelling bottom-up opportunities.

Greece: 2023

Score: Headwinds to Neutral

In Q2 2023, Ashmore upgraded Greece from ‘Challenges’ to ‘Neutral’ on an improved economic growth trajectory, a reducing fiscal burden, deleveraging households and the re-election of an orthodox government with a pro-reform agenda.

——

At points of time in the cycle, top-down impacts can dominate and overwhelm stock returns, especially in US dollar terms. To successfully mitigate macro risks requires experience to understand policy scenarios, a wide breadth of vantage points to connect interrelated drivers, as well as a systematic framework to ensure consistency of assessment and an explicit impact on portfolio construction.

Differentiated outcomes

There’s a range of differentiators that EM investors can seek when making investment decisions. These include six differentiated outcomes prioritised by Ashmore:

 Stock idiosyncratic

With a stock idiosyncratic approach, no single top-down, style factor nor stock should dominate portfolio outcomes. This ensures an EM equity portfolio is diversified across best stock ideas with capital allocation maximised by the prevailing rating discipline.

Importantly, a stock idiosyncratic approach should enable an EM equity strategy’s outperformance of the MSCI Emerging Markets index to be sustainable over the market cycle.

Portfolio active risk should evidence several stable portfolio attributes; namely a consistent, but not dominant, style underpinning of quality and growth attributes, and the disproportionate importance of stock idiosyncratic risk.

‘Sustained’ not ‘high’ quality

Companies with high historical returns on capital may appear attractive ex-post. However, those with sustained forward looking quality attributes have the potential to exceed market expectations by sustaining strong robust returns. Their resilience across economic cycles and varied business conditions makes their earnings power more dependable, which the market ultimately rewards.

The greater the predictability of a company’s earnings, cash flows, and management execution, the higher the valuation multiple investors are typically willing to assign. Moreover, companies that exhibit enduring quality often navigate market downturns more effectively, emerging stronger and gaining share from weaker competitors.

In short, a focus on enduring quality not only supports return potential but also enhances the portfolio’s overall risk-reward profile.

‘Diversified’ not ‘high’ growth

Investment in high-growth companies in EM is attractive given significant structural tailwinds, yet there are important further considerations.

A portfolio biased exclusively to high growth companies can make portfolio returns unstable and impede a manger’s ability to compound alpha. Style based momentum investing can also create market distortions.

Instead, investing in companies with a range of growth drivers enables the EM manager to take advantage of market dislocations and helps the portfolio navigate a range of market cycles. Growth categories include:

Rapid growers: firms experiencing strong, secular growth supported by long-term tailwinds.

Mid growers: businesses with dominant industry positions and high visibility of durable growth.

Cyclical growers: quality companies in cyclical sectors where near-term growth visibility is stronger, though longer-term visibility may be limited.

As an EM strategy moves through the business cycle, companies compete for capital. In the case of Ashmore, its disciplined rating framework causes exposure to each growth category to ebb and flow over time.

‘All Cap’

Ashmore believes that researching small- and mid-capitalisation (SMID) stocks can be particularly rewarding. When management teams allocate capital effectively, a company’s competitive advantage can strengthen as it scales, leading to the potential for exceptional long-term returns. This effect is often amplified in businesses that are still in the early stages of developing and enhancing their competitive edge.

An ‘all-cap’ approach to EM investing has proven accretive to alpha over time, with SMID companies frequently ranking among top contributors to performance.

Maximising capital allocation

There is greater potential for mispricing in emerging markets and hence valuation discipline has outsized importance. Ashmore systematically implements valuation discipline through its stock ratings which trigger the resizing of positions.

The most frequent driver of changes in position size is related to valuation, followed by a change in the growth profile of a company, and lastly by a quality reassessment. This reflects the inherent high volatility that is exhibited in emerging markets, even for high quality companies.

Performance over a cycle

By targeting investment in companies with sustained quality and diversified growth attributes which can be resilient to, and benefit from, the transformative economies that they operate in, an EM manager is better positioned to deliver positive investor outcomes.

The characteristics Ashmore targets are designed to enable EM equity strategies to mitigate permanent loss of capital risk but not at the expense of participating in strong market backdrops.

The manager does not seek to be structurally ‘defensive’, nor does it target the minimalisation of volatility as a strategy outcome. Indeed, it avoids low growth companies, such as telecommunications and utilities, despite them displaying low volatility characteristics. This approach reflects the risks of misallocation of capital as they attempt to grow, and since they forgo the attractive growth opportunity inherent in emerging markets investing.

Ashmore’s approach seeks to exploit episodes of market volatility systematically. Changing market expectations for company growth profiles, as well as market discount rates, can lead to sharp fluctuations in EM company stock prices. However, this has no bearing on the quality of the company, and Ashmore’s investment process systematically seeks to exploit such volatility underpinned by its rating discipline.

The importance of a valuation discipline means the firm is careful not to “overpay” for attractive growth. Finding such valuation opportunities can often coincide with market uncertainty around a particular company which can then be exploited. Typically, once the company fundamentals become clearer to the market, the volatility of the stock subsides, and investors are rewarded.

An EM equity approach that focuses on maximising investment returns over a cycle means that investment decisions, as well as primary evaluations, are made over this time frame.

One of the key determinants for future returns is whether a company’s competitive advantages can be sustained or improved upon. This enduring quality attribute is rewarded by the market over the medium to long term, although, over shorter periods, it may be overshadowed by economic or sectoral cycles, especially given greater macro volatility in emerging markets.

Advisers looking to include an EM equity strategy into client portfolios should look for experienced managers that focus on the importance of compounding earnings, the nature of which is evident over the medium term, yet less so over shorter-term periods.

By combining an asset ownership mindset with a systematic investment process, a quality EM manager is able to exploit mispricings in quality growth fundamentals dispassionately. This has the potential to result in significant and sustained alpha generation and deliver positive outcomes for your clients.

 

Take the FAAA accredited quiz to earn 0.5 CPD hour:

CPD Quiz

The following CPD quiz is accredited by the FAAA at 0.5 hour.

Legislated CPD Area: Technical Competence (0.5 hrs)

ASIC Knowledge Requirements: Managed Investments (0.25 hrs) and Securities (0.25 hrs)

 

———–
Important information: The information included in this article is provided for informational purposes only. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Ashmore Investment Management, PAN-Tribal Asset Management Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.
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Combining an asset ownership mindset with a systematic investment process has the potential to result in significant and sustained alpha generation and deliver positive outcomes for your clients.

Emerging markets (EM) are highly inefficient. Complicated governance structures, evolving macroeconomics and immature institutions result in elevated stock price volatility. This creates significant alpha generation opportunities, as well as challenges, for active investors in EM equity markets.

EM specialist Ashmore believes that companies with structural competitive advantages delivering growth are best placed to benefit from EM secular growth drivers, as well as being well placed to navigate economic and market drawdowns.

Furthermore, opportunities to generate alpha are amplified by the fact that EM companies are poorly researched, especially for their medium-term fundamentals. Consequently, businesses of enduring quality are often undervalued and trade at prices that fail to reflect their ability to sustain high returns over the long term.

The compounding power of quality and growth in EM

The three characteristics most important to selecting quality EM companies are:

  1. Sustained quality, companies with enduring competitive advantages
  2. Diversified growth, compounding through reinvestment
  3. Mispriced valuation, with mispriced medium-term fundamentals

The combination of these factors is best positioned to deliver a portfolio of EM equities that meets it investment objectives and investor expectations.

Sustained quality

Quality companies typically share four important characteristics.

  1. High and sustainable return on capital
    • Superior returns can be eroded by competition over time. Only a small number of companies have structural competitive advantages that can sustain high returns on capital.
    • High returns can arise for a short-term period during industry or macro upturns. However, only few companies sustain their strong returns through cycles; the path to successful investing lies in identifying them.
  1. Strong predictable cash flow generation
    • This provides the foundation for a company to be able to make the correct investment decisions over a cycle.
    • Reported earnings can be subject to accounting presentation while cash generation rarely lies and ultimately determines the value of a business.
  1. Robust balance sheet
    • This enables companies to improve their competitive position during a macro downturn. For example, they can invest in their brands, technology, distribution and growth while others are retrenching.
    • Excessive leverage can lead to large negative outcomes for equity investors and can destroy even the best business models.
  1. Skilful management and non-financial factors
    • Capital allocation provides the link between business value and shareholder value. Long-term orientated companies that understand and address material non-financial exposures to the benefit of all stakeholders can sustain and expand their competitive advantage.
    • A skilled management team can continue to reinvest cash at high rates of return and grow the underlying earnings power of a business.

Identifying structural quality attributes requires an understanding of how a company achieves its attractive economic characteristics to ensure they are sustainable. Companies with high historic returns on investment capital (ROIC) can be identified though quantitative screens. However, one of the key determinants for future returns is a qualitative assessment of whether competitive advantages can be sustained or even improved upon.

Competitive advantages are distinct characteristics that are difficult to replicate and therefore enable super normal returns to be sustained. Sources of structural advantages usually comprise one of the following:

  • Intangible assets: including intellectual property, licenses and brands.
  • Cost advantages: driven by a proprietary process, superior scale or niche positioning.
  • Network effects: a system’s value increases as the number of users expands e.g. as a social network or marketplace.
  • Switching costs: products with high benefit/cost ratios where the risk of changing provider is high.

If a company’s management team allocates capital correctly, the company’s competitive advantage can expand as the company grows which leads to the potential for strong returns. Stocks can defy market expectations for competitive advantages to erode and ROICs to reduce to industry average, thereby creating the opportunity for sustained outperformance.

This positive effect is amplified for companies at an earlier stage of developing a competitive advantage. Consequently, focusing on companies with ‘consistent’, as well as ‘improver’, ROE profiles can often be well rewarded (see figure one).

Diversified growth

There are multiple factors to consider when targeting companies with durable growth characteristics. These include:

  • Durable growth over high growth: many companies are predicted to generate high growth yet only a select few actually deliver. Consequently, identifying realistic and durable growth drivers is key, as is being selective.
  • Compounding growth through reinvestment: growth is most attractive when combined with quality as this enables a virtuous cycle whereby free cash flow can be re-invested at high rates of return. Taken in combination with a long runway for high return investment opportunities, this enables capital to be compounded over many years.

The power of compounding earnings is not perceptible in the short term. Instead, most shareholder returns are reflected via changes in earnings multiples. However, over the longer term, it is growth and compounding of cash flows and earnings that can lead to extraordinary returns.

  • Preference for diversified growth drivers: Growth drivers can include price increases, entering new markets, new product development, cost reduction and operating leverage.

Cyclical growth that is driven predominantly by economic expansion and external factors cannot be relied upon. It is uncontrolled by management and can quickly disappear so requires additional analysis.

Growth driven by market share gains, product innovation and other initiatives is more durable as it is independent of the economic climate and is inherently more controllable.

  • The perils of low growth: beyond a lack of compounding, limited growth opportunities can often be value destructive. It can lead management teams under pressure from shareholders to allocate outside their core competency.
  • Timeframe and forecast error: while long term profitability attributes are targeted, our experience has been that the value of financial forecasting and its accuracy starts to diminish after a five-year time horizon, especially during periods of heightened technology disruption.

Mispriced valuation

Valuation discipline is important, otherwise you could be paying for the next 3-5 years of shareholder returns upfront, which meaningfully limits the total returns you are likely to make.

We believe companies with high quality attributes over the near term often trade at a premium to the broader market. This reflects some expectation of short-term operational outperformance.

However, over the longer run, businesses that can sustain their quality attributes are able to exceed expectations by maintaining high levels of profitability. Stock prices typically discount high rates of return being competed away and thus systematically undervalue quality companies.

The strongest examples of quality businesses with durable growth prospects can be held over the long run, unless market expectations become excessive. However, the potential for forecast error means position sizes should always be adjusted to the upside available.

The importance of top down

EM companies lead the world in a wide range of industries, yet they sit in economies with often immature institutions. The outcome is potentially higher stock returns but also the risk of macroeconomic volatility. This is highlighted by the significant dispersion in EM between best-to-worst country performance each calendar year (figure four).

Macroeconomic factors can, therefore, be the dominant driver of returns in the short term, often via currency impact and market multiples. Over the medium term, top down can impact a company’s operating environment and growth opportunity. Consequently, we believe an explicit assessment and integration of top down in our investment approach can help sustain alpha generation over the long run.

The use of top-down factors

By way of illustration, although Ashmore’s EM equity strategy is primarily driven by bottom-up fundamental conviction, top-down analysis plays three significant roles:

  1. A risk overlay which aims to mitigate major macro headwinds.
  2. To steer the portfolio away from economies facing headwinds.
  3. An idea generation tool attracting us to positive macro trajectories.

Further, Ashmore believes it is important to generate a proprietary team top-down view to ensure its alignment and full integration into the investment process. Each quarter the team scores countries formally, framed by a Country Scorecard. This assesses nearer team leading indicators, as well as longer term structural macroeconomic drivers, including institutions/politics.

Key top-down drivers that are assessed and scored include economic activity, the monetary cycle, fiscal accounts, external accounts, private debt and politics.

Drawing on Ashmore’s macro research, country analysis is undertaken by the member of the team responsible for stock research in that geography. This serves to frame the operating environment for their company research. Consistent macro scoring principles are applied to both short- and longer-term indicators to produce an overall rating, which impacts portfolio construction.

Case study: Country score examples

China: 2023-25

Score: Headwinds

This rating reflects a combination of poor corporate and consumer confidence weighing on activity. Together with an ineffective fiscal policy response, this is leading the economy to offset real estate pressure only modestly. Policy visibility has improved, and the private sector has seen support which has improved our conviction on select stock opportunities, but Ashmore continues to cap its China overweight until there is greater clarity over tariff risk and domestic policy.

Russia: 2022

Score: Neutral to Headwinds

In Q1 2022 Ashmore had a long-standing overweight to the market and a Neutral macro rating. It was then downgraded to ‘Headwinds’ due to rising tail risks of a war with Ukraine, which led to the overweight being meaningfully reduced ahead of the invasion. Ashmore did not go to a zero weight – i.e. ‘Major headwinds’ – as the team did not expect the invasion to materialise.

South Africa: 2022-24

Score: Major Headwinds to Neutral

In Q1 2022 Ashmore changed the rating from ‘Headwinds’ to ‘Major Headwinds’. The economy had many pre-existing challenges which ranged from poor infrastructure and weak institutions to emigration of the highly educated. Ashmore downgraded the rating given lack of political reform progress and crippling electricity blackouts.

The assessment has since improved following elections in May 2024 and the establishment of a coalition that includes the more reform orientated Democratic Alliance, as well as less pressure from electricity shortages. This led to a ‘Neutral’ view. The outlook remains uncertain, though, with limited compelling bottom-up opportunities.

Greece: 2023

Score: Headwinds to Neutral

In Q2 2023, Ashmore upgraded Greece from ‘Challenges’ to ‘Neutral’ on an improved economic growth trajectory, a reducing fiscal burden, deleveraging households and the re-election of an orthodox government with a pro-reform agenda.

——

At points of time in the cycle, top-down impacts can dominate and overwhelm stock returns, especially in US dollar terms. To successfully mitigate macro risks requires experience to understand policy scenarios, a wide breadth of vantage points to connect interrelated drivers, as well as a systematic framework to ensure consistency of assessment and an explicit impact on portfolio construction.

Differentiated outcomes

There’s a range of differentiators that EM investors can seek when making investment decisions. These include six differentiated outcomes prioritised by Ashmore:

 Stock idiosyncratic

With a stock idiosyncratic approach, no single top-down, style factor nor stock should dominate portfolio outcomes. This ensures an EM equity portfolio is diversified across best stock ideas with capital allocation maximised by the prevailing rating discipline.

Importantly, a stock idiosyncratic approach should enable an EM equity strategy’s outperformance of the MSCI Emerging Markets index to be sustainable over the market cycle.

Portfolio active risk should evidence several stable portfolio attributes; namely a consistent, but not dominant, style underpinning of quality and growth attributes, and the disproportionate importance of stock idiosyncratic risk.

‘Sustained’ not ‘high’ quality

Companies with high historical returns on capital may appear attractive ex-post. However, those with sustained forward looking quality attributes have the potential to exceed market expectations by sustaining strong robust returns. Their resilience across economic cycles and varied business conditions makes their earnings power more dependable, which the market ultimately rewards.

The greater the predictability of a company’s earnings, cash flows, and management execution, the higher the valuation multiple investors are typically willing to assign. Moreover, companies that exhibit enduring quality often navigate market downturns more effectively, emerging stronger and gaining share from weaker competitors.

In short, a focus on enduring quality not only supports return potential but also enhances the portfolio’s overall risk-reward profile.

‘Diversified’ not ‘high’ growth

Investment in high-growth companies in EM is attractive given significant structural tailwinds, yet there are important further considerations.

A portfolio biased exclusively to high growth companies can make portfolio returns unstable and impede a manger’s ability to compound alpha. Style based momentum investing can also create market distortions.

Instead, investing in companies with a range of growth drivers enables the EM manager to take advantage of market dislocations and helps the portfolio navigate a range of market cycles. Growth categories include:

Rapid growers: firms experiencing strong, secular growth supported by long-term tailwinds.

Mid growers: businesses with dominant industry positions and high visibility of durable growth.

Cyclical growers: quality companies in cyclical sectors where near-term growth visibility is stronger, though longer-term visibility may be limited.

As an EM strategy moves through the business cycle, companies compete for capital. In the case of Ashmore, its disciplined rating framework causes exposure to each growth category to ebb and flow over time.

‘All Cap’

Ashmore believes that researching small- and mid-capitalisation (SMID) stocks can be particularly rewarding. When management teams allocate capital effectively, a company’s competitive advantage can strengthen as it scales, leading to the potential for exceptional long-term returns. This effect is often amplified in businesses that are still in the early stages of developing and enhancing their competitive edge.

An ‘all-cap’ approach to EM investing has proven accretive to alpha over time, with SMID companies frequently ranking among top contributors to performance.

Maximising capital allocation

There is greater potential for mispricing in emerging markets and hence valuation discipline has outsized importance. Ashmore systematically implements valuation discipline through its stock ratings which trigger the resizing of positions.

The most frequent driver of changes in position size is related to valuation, followed by a change in the growth profile of a company, and lastly by a quality reassessment. This reflects the inherent high volatility that is exhibited in emerging markets, even for high quality companies.

Performance over a cycle

By targeting investment in companies with sustained quality and diversified growth attributes which can be resilient to, and benefit from, the transformative economies that they operate in, an EM manager is better positioned to deliver positive investor outcomes.

The characteristics Ashmore targets are designed to enable EM equity strategies to mitigate permanent loss of capital risk but not at the expense of participating in strong market backdrops.

The manager does not seek to be structurally ‘defensive’, nor does it target the minimalisation of volatility as a strategy outcome. Indeed, it avoids low growth companies, such as telecommunications and utilities, despite them displaying low volatility characteristics. This approach reflects the risks of misallocation of capital as they attempt to grow, and since they forgo the attractive growth opportunity inherent in emerging markets investing.

Ashmore’s approach seeks to exploit episodes of market volatility systematically. Changing market expectations for company growth profiles, as well as market discount rates, can lead to sharp fluctuations in EM company stock prices. However, this has no bearing on the quality of the company, and Ashmore’s investment process systematically seeks to exploit such volatility underpinned by its rating discipline.

The importance of a valuation discipline means the firm is careful not to “overpay” for attractive growth. Finding such valuation opportunities can often coincide with market uncertainty around a particular company which can then be exploited. Typically, once the company fundamentals become clearer to the market, the volatility of the stock subsides, and investors are rewarded.

An EM equity approach that focuses on maximising investment returns over a cycle means that investment decisions, as well as primary evaluations, are made over this time frame.

One of the key determinants for future returns is whether a company’s competitive advantages can be sustained or improved upon. This enduring quality attribute is rewarded by the market over the medium to long term, although, over shorter periods, it may be overshadowed by economic or sectoral cycles, especially given greater macro volatility in emerging markets.

Advisers looking to include an EM equity strategy into client portfolios should look for experienced managers that focus on the importance of compounding earnings, the nature of which is evident over the medium term, yet less so over shorter-term periods.

By combining an asset ownership mindset with a systematic investment process, a quality EM manager is able to exploit mispricings in quality growth fundamentals dispassionately. This has the potential to result in significant and sustained alpha generation and deliver positive outcomes for your clients.

 

Take the FAAA accredited quiz to earn 0.5 CPD hour:

CPD Quiz

The following CPD quiz is accredited by the FAAA at 0.5 hour.

Legislated CPD Area: Technical Competence (0.5 hrs)

ASIC Knowledge Requirements: Managed Investments (0.25 hrs) and Securities (0.25 hrs)

 

———–
Important information: The information included in this article is provided for informational purposes only. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Ashmore Investment Management, PAN-Tribal Asset Management Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.

The post CPD: The investment potential in emerging market equities appeared first on AdviserVoice.

]]> https://www.adviservoice.com.au/2025/10/cpd-the-investment-potential-in-emerging-market-equities/feed/ 0 CPD: A multi-year tailwind for EM assets https://www.adviservoice.com.au/2025/07/cpd-a-multi-year-tailwind-for-em-assets/ https://www.adviservoice.com.au/2025/07/cpd-a-multi-year-tailwind-for-em-assets/#respond Tue, 29 Jul 2025 21:30:59 +0000 https://www.adviservoice.com.au/?p=105155

US international debt has ballooned to over $26 trillion, is now showing clear signs of peaking.

A seismic shift is underway in global capital markets. The extreme concentration in US assets, a phenomenon driven by fiscal policies that ballooned the $US international debt to over 26 trillion, is now showing clear signs of peaking. Emerging markets specialist Ashmore believe the powerful tailwinds that lifted US equities are abating, setting the stage for a rotation into other markets.

Several catalysts are accelerating this transition. Externally, stronger growth outlooks in key economies such as Germany and China are increasing their appeal. Internally, the necessary move to tackle the US fiscal and current account deficits will likely pressure the dollar and domestic earnings, prompting global investors and central banks to look elsewhere.

The large US fiscal and external imbalances mean the US dollar is no longer the ‘safe haven’ it once was. While it is likely to remain the largest currency in reserve manager portfolios and trade/capital account settlements, the weight in other currencies will increase due to settlement alternatives and diversification.

This creates a historic opportunity for emerging markets (EMs). Many EMs now present a compelling investment case with strong fundamentals, high real yields and significant growth potential. As the global portfolio rebalances and de-dollarisation gains momentum, EMs are primed to capture substantial new inflows, potentially driving a new era of outperformance.

The inconvenient truth

There is a clear disconnect between the narrative and the reality behind US exceptionalism. The narrative is well known. Despite no longer being the single dominant force in global trade and economics, the US remains a leader through its reserve currency. Its world-beating education sector, openness to talented immigration and dog-eat-dog capitalism have also kept the US at the cutting edge of innovation, where its great minds have built the world’s leading technology companies, and its most advanced weapons. Both are difficult to replicate.

Nevertheless, all this has been part of the greatness of America for a century. During this period, the dollar has had major peaks and troughs, and US equities and fixed income valuations have traded at a wide premium to global assets, and sometimes, even, at a discount. What has driven US assets, particularly equities, to historic valuation premiums in the last decade has not been its century-old structural advantages, but additional macro forces.

The outperformance of the US in recent years has been underpinned by the shale oil revolution and the large pro-cyclical fiscal stimulus since Donald Trump’s first term. However, the magnitude of the imbalances within the US government budget will now make it very difficult for the US to keep sustaining the macro environment that has led to its equity market exceptionalism. Further fiscal expansion may bring unsurmountable macro imbalances and higher bond yields, which are likely to destabilise financial markets. Fiscal consolidation is now the only lucid policy direction to follow, in Ashmore’s view. However, this would directly hit US companies’ earnings.

The sharp increase in US equity market volatility corroborates this policy conundrum. This year, US stocks had a 20% drawdown and the fastest recovery on record, associated with the 2 April reciprocal tariff announcement and various stages of capitulation since.

Where to re-allocate

Some strategists claim US stocks are a better place to invest than bonds, as in their view, the government is unlikely to consolidate its gargantuan fiscal deficit. As the argument goes, large deficits keeping nominal GDP growth elevated would be a positive environment for stocks, particularly for high-quality companies, like the ‘Magnificent Seven’, which are better equipped to pass inflation through to prices and thus benefit from ongoing fiscal largesse.

History shows, however, that equities are not always a good inflation hedge. From 1968 to 1978, US stocks underperformed bonds meaningfully as inflation rose from 3.0% to average 6.5% over the period, with a high of 12.3% in 1974.

Gold (+201%), real estate (+14%), and BBB bonds (+4%) held their ground well during this decade (1968-1978). Ten-year bonds sold off by 16%, but the S&P 500 was down 28% and small caps dropped 40%. The S&P 500 and small caps had huge drawdowns of 40% and 80%, respectively from 1968 to 1974, as shown in figure one.

The recent surge in bond yields threatens market stability, particularly in high valuation stocks. It represents declining confidence in fiscal trajectories, exacerbated by the surge in interest expense due to rising global debt stock. Low valuation equities in the rest of the world (figure two), with earnings predominantly in currencies that are not being debased, represents a much better bet, with risk skewed to the upside.

Who holds most US assets?

a. Private vs. official sectors

The US is the largest net debtor country in the world, by far. Its net liabilities to the rest of the world have reached USD 26 trillion, equivalent to 88% of US GDP. This comprises USD 62 trillion of foreign ownership of US assets (a liability for the US) against USD 36 trillion of US investments abroad (an asset for the US).

In the last 20 years, the private sector has been increasing exposure to the US and today controls the lion’s share of portfolio investments. The ratio of private to official owners of US assets has increased five-fold from 1.5x in 2009 to 4x in 2024, with assets rising from around USD 5trillion to USD 25 trillion. This means that just a 5% reduction of US asset exposure by foreign investors would amount to USD 1.25 trillion of outflows at current valuations.

b. Europe

Europeans now hold USD 14 trillion in US portfolio assets, of which, USD 9 trillion is in equities. The improving European investment outlook and deteriorating US outlook should drive significant  reallocation of capital back to Europe.

The majority of US equity exposure is unhedged, since the dollar would typically strengthen in a risk-off environment. Nevertheless, this relationship has changed in 2025 (see US dollar analogy later in this article), leading many EU investors to hedge their exposure.

It is conceivable there will be significant repatriation flows from European investors. This will be supported by the large fiscal expansion leading to significant investment opportunities in European equities as well as more issuance of high-quality European debt as well as a historically cheap euro. This would likely drive significant US capital account outflows.

c. Asia

Asian countries that have run large current account surpluses with the US over recent years have built correspondingly large holdings in US assets, as these surpluses have largely been recycled back into US stocks and bonds. Asian investors have a more conservative investor profile (as more of the assets are held by the official sector), with close to 55% of their USD 9 trillion of US exposure in bonds.

China and Japan still have by far the largest US holdings, even though Japan has trimmed its bond holdings in recent years. The raw data suggests China has been a seller of US assets, but it is assumed some of China’s UST holdings are now held in Belgium and Luxembourg, the domicile of Clearstream and Euroclear.

In nominal terms, but particularly in relation to the size of their domestic economies, South Korea and Taiwan now have significant positions in US assets. Korea holds USD 750 billion in US stocks and bonds, 40% of its GDP. Taiwan holds USD 820 billion of US assets, 105% of its GDP. Notably, USD 664 billion of this position is in bonds, which makes Taiwan the largest holder of US bonds in the world relative to the size of its economy. The recent spike in the TWD as investors began to speculate on the repatriation, or at least hedging, of some of this position demonstrates how significant a shift in positioning from Taiwanese investors could be for foreign exchange (FX) markets.

It is also well known that several Asian exporters have been hoarding dollars, as it gave them a higher yield than local currency and, until recently, a weakening JPY and RMB kept their currencies under pressure. With the recent strengthening of the JPY, most Asian currencies including the TWD, KRW, MYR and RMB, started to rise as well. This is likely to trigger significant rebalancing of investor and corporate currency exposure.

Institutional policies

Several narratives and facts are likely to drive a multi-year diversification away from US assets and the dollar.

  • The weaponisation of the US dollar payment system via sanctions is encouraging neutral and non-aligned countries to seek alternatives.
  • Geopolitics: Escalation of conflicts that force the US to spend more on defence (Ukraine, Israel) have been driving central banks to diversify out of US Treasuries.
  • Less open economy: Barriers for trade, education, and immigration – as well as forcing US companies to manufacture in the US – will lead to higher prices and lower margins. Less immigration and more deportations will lead to lower potential growth and add inflationary pressures, particularly for low value-add services, construction, and manufacturing industries. The ongoing struggle with Harvard University is likely to push students towards universities in other countries.
  • Institutions and the rule of law: Trump has threatened to sack Federal Reserve Chair Jerome Powell, has accused large legal firms of being partisan, and has installed close aides across key establishments, including the Supreme Court. Ashmore believes the US institutional decay predates Trump. There has long been a partisan schism leading to a severely dysfunctional Congress, which has been increasingly dominated by interest groups (i.e., lobbyists for various industries such as weapons, pharma, and tech). Congress has become increasingly transactional, leading to a more ineffective government balance.
  • Foreign policy: The current administration’s bashing of key allies such as Europe and opponents like China, means these governments are mobilising to become more self-sufficient. Foreign investors thus have more opportunities to invest at home and to fear a less friendly US administration.
  • Poor infrastructure: Investors betting on another decade of technology stock hegemony are missing a bigger point. There is no AI scaling without a massive increase in energy generation and heavy investment on the energy grid to support transition and distribution. The overload blackouts in Portugal and Spain last month, and the UK paying for energy generation companies to stop producing attractively priced wind renewable energy in the North Sea, shows the world is neither ready for the energy transition nor for an increase in energy demand. The next big equity investment opportunities, therefore, are likely to be in project finance. This is a space where Japan, Germany, and China outperform the US.
  • External imbalances: The US current account deficit, excluding oil, is at a record high of 5% of GDP.
  • Dollar settlement: Since the US is energy self-sufficient, exporting countries’ surplus have relocated to other places such as China, Europe, Japan and India. Even though oil is still priced in dollars, China has been successful at settling oil imports in RMB. This means oil exporters need to make an active decision to invest their surplus in the US. As the US has been actively debasing its currency since the pandemic, reserve managers have been prioritising gold. But the dollar has still been the leading currency for settlement, given the lack of alternatives. Not anymore. The BIS and the BRICS have been working on cryptocurrency projects (mBRIDGE and BRICS Pay) that could bypass the dollar system[1]. BRICS Pay is interesting as it is a crypto currency partially backed by gold and a basked of BRICS currencies, making it a good candidate for settlement and reserve assets.
  • US rebalancing: Imbalances do not mean that things will change. But the US administration is openly very keen to lower the external imbalance of a historical high current account deficit. Scott Bessent, United States Secretary of the Treasury is encouraging Europe and Japan as they implement policies that are leading to a strengthening of their own currencies. This is where the fiscal policy is key. Bessent understands there will be no external rebalancing without an increase in the US savings rates (lower fiscal deficit) and a simultaneous lowering of Chinese and German savings.
  • Foreign rebalancing: The fiscal expansion in Germany guarantees lower savings rates and more recycling of Northern European surplus. China is perhaps waiting for the US to show it is serious about lowering its fiscal deficit before attempting to support more consumption. After all, moving from an export-led to a consumption-led growth model is a major challenge. If the US does not rebalance its fiscal deficits, its external accounts will also remain imbalanced. In this scenario, higher tariffs on China would lead to a lot of re-routing, but China would retain its position as the largest exporter in the world and the US the largest importer, even if the bilateral trade declines.

Correlations breaking down: From the ‘dollar smile’ to the ‘dollar frown’

Another factor that should make it evident the US leadership position is eroding is the breakdown of the ‘dollar smile’ relationship. This elegant and simple model was created by then-Morgan Stanley currency strategist Stephen Jen. He posited that the dollar would strengthen both during periods when the US economy is outperforming the rest of the world, but also during a risk-off recessionary shock. The dollar could only weaken when the rest of the world’s growth was outperforming the US, in a benign macro backdrop.

An analysis of the mechanics of the model explains why it broke down in 2025. Anti-fragile currencies that benefit from recessions are those from countries that are net creditors to the rest of the world, like Switzerland or Japan. In a recession or severe risk-off events, Japanese and Swiss managers are forced to cut risk in their portfolio, which can be achieved either by selling foreign assets to buy local assets or hedging the FX exposure of foreign assets. Both flows drive the CHF and JPY stronger.

The US dollar, however, is a currency of the largest net debtor in the world. The dollar smile only worked since Alain Greenspan’s tenure (when the Fed started to promptly react to market volatility) because foreign investors would buy more ‘risk-off’ US Treasuries than they would sell ‘risk-on’ US equities, leading to an inflow to the US capital account that strengthened the dollar. But with inflation above the Fed’s target and severe question marks posed by tariffs, the Fed is not currently likely to cut rates in response to market volatility.

The simple logic of mean reversion suggests that no trend lasts forever – and the extraordinary outperformance of US equities is no exception. For years, a massive global concentration in US assets has been fuelled by fiscal expansion, pushing the nation’s net international investment liability to an unprecedented 26 trillion.

Since the change in the US administration last November, there have been seen signs of a pivotal shift. Abroad, renewed growth prospects in Germany and China—two of the US’s largest creditors—are creating attractive alternatives for investment. At home, the inevitable focus on reining in the twin deficits threatens to pressure US earnings and the dollar, further encouraging diversification.

This environment creates powerful tailwinds for emerging markets. The sheer scale of global exposure to the US means that even a minor rotation can have a major impact on the comparatively smaller EM capital markets. With their compelling combination of attractive valuations, high real yields, and improving fundamentals, emerging markets are well-positioned to capture the coming wave of inflows from investors seeking value, growth and diversification away from the dollar.

Take the FAAA accredited quiz to earn 0.25 CPD hour:

CPD Quiz

The following CPD quiz is accredited by the FAAA at 0.25 hour.

Legislated CPD Area: General (0.25 hrs)

ASIC Knowledge Requirements: Economic Environment (0.25 hrs)

———

Notes:
[1] https://www.bis.org/about/bisih/topics/cbdc/mcbdc_bridge.htm
Important information: The information included in this article is provided for informational purposes only. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Ashmore Investment Management, PAN-Tribal Asset Management Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.
]]>

US international debt has ballooned to over $26 trillion, is now showing clear signs of peaking.

A seismic shift is underway in global capital markets. The extreme concentration in US assets, a phenomenon driven by fiscal policies that ballooned the $US international debt to over 26 trillion, is now showing clear signs of peaking. Emerging markets specialist Ashmore believe the powerful tailwinds that lifted US equities are abating, setting the stage for a rotation into other markets.

Several catalysts are accelerating this transition. Externally, stronger growth outlooks in key economies such as Germany and China are increasing their appeal. Internally, the necessary move to tackle the US fiscal and current account deficits will likely pressure the dollar and domestic earnings, prompting global investors and central banks to look elsewhere.

The large US fiscal and external imbalances mean the US dollar is no longer the ‘safe haven’ it once was. While it is likely to remain the largest currency in reserve manager portfolios and trade/capital account settlements, the weight in other currencies will increase due to settlement alternatives and diversification.

This creates a historic opportunity for emerging markets (EMs). Many EMs now present a compelling investment case with strong fundamentals, high real yields and significant growth potential. As the global portfolio rebalances and de-dollarisation gains momentum, EMs are primed to capture substantial new inflows, potentially driving a new era of outperformance.

The inconvenient truth

There is a clear disconnect between the narrative and the reality behind US exceptionalism. The narrative is well known. Despite no longer being the single dominant force in global trade and economics, the US remains a leader through its reserve currency. Its world-beating education sector, openness to talented immigration and dog-eat-dog capitalism have also kept the US at the cutting edge of innovation, where its great minds have built the world’s leading technology companies, and its most advanced weapons. Both are difficult to replicate.

Nevertheless, all this has been part of the greatness of America for a century. During this period, the dollar has had major peaks and troughs, and US equities and fixed income valuations have traded at a wide premium to global assets, and sometimes, even, at a discount. What has driven US assets, particularly equities, to historic valuation premiums in the last decade has not been its century-old structural advantages, but additional macro forces.

The outperformance of the US in recent years has been underpinned by the shale oil revolution and the large pro-cyclical fiscal stimulus since Donald Trump’s first term. However, the magnitude of the imbalances within the US government budget will now make it very difficult for the US to keep sustaining the macro environment that has led to its equity market exceptionalism. Further fiscal expansion may bring unsurmountable macro imbalances and higher bond yields, which are likely to destabilise financial markets. Fiscal consolidation is now the only lucid policy direction to follow, in Ashmore’s view. However, this would directly hit US companies’ earnings.

The sharp increase in US equity market volatility corroborates this policy conundrum. This year, US stocks had a 20% drawdown and the fastest recovery on record, associated with the 2 April reciprocal tariff announcement and various stages of capitulation since.

Where to re-allocate

Some strategists claim US stocks are a better place to invest than bonds, as in their view, the government is unlikely to consolidate its gargantuan fiscal deficit. As the argument goes, large deficits keeping nominal GDP growth elevated would be a positive environment for stocks, particularly for high-quality companies, like the ‘Magnificent Seven’, which are better equipped to pass inflation through to prices and thus benefit from ongoing fiscal largesse.

History shows, however, that equities are not always a good inflation hedge. From 1968 to 1978, US stocks underperformed bonds meaningfully as inflation rose from 3.0% to average 6.5% over the period, with a high of 12.3% in 1974.

Gold (+201%), real estate (+14%), and BBB bonds (+4%) held their ground well during this decade (1968-1978). Ten-year bonds sold off by 16%, but the S&P 500 was down 28% and small caps dropped 40%. The S&P 500 and small caps had huge drawdowns of 40% and 80%, respectively from 1968 to 1974, as shown in figure one.

The recent surge in bond yields threatens market stability, particularly in high valuation stocks. It represents declining confidence in fiscal trajectories, exacerbated by the surge in interest expense due to rising global debt stock. Low valuation equities in the rest of the world (figure two), with earnings predominantly in currencies that are not being debased, represents a much better bet, with risk skewed to the upside.

Who holds most US assets?

a. Private vs. official sectors

The US is the largest net debtor country in the world, by far. Its net liabilities to the rest of the world have reached USD 26 trillion, equivalent to 88% of US GDP. This comprises USD 62 trillion of foreign ownership of US assets (a liability for the US) against USD 36 trillion of US investments abroad (an asset for the US).

In the last 20 years, the private sector has been increasing exposure to the US and today controls the lion’s share of portfolio investments. The ratio of private to official owners of US assets has increased five-fold from 1.5x in 2009 to 4x in 2024, with assets rising from around USD 5trillion to USD 25 trillion. This means that just a 5% reduction of US asset exposure by foreign investors would amount to USD 1.25 trillion of outflows at current valuations.

b. Europe

Europeans now hold USD 14 trillion in US portfolio assets, of which, USD 9 trillion is in equities. The improving European investment outlook and deteriorating US outlook should drive significant  reallocation of capital back to Europe.

The majority of US equity exposure is unhedged, since the dollar would typically strengthen in a risk-off environment. Nevertheless, this relationship has changed in 2025 (see US dollar analogy later in this article), leading many EU investors to hedge their exposure.

It is conceivable there will be significant repatriation flows from European investors. This will be supported by the large fiscal expansion leading to significant investment opportunities in European equities as well as more issuance of high-quality European debt as well as a historically cheap euro. This would likely drive significant US capital account outflows.

c. Asia

Asian countries that have run large current account surpluses with the US over recent years have built correspondingly large holdings in US assets, as these surpluses have largely been recycled back into US stocks and bonds. Asian investors have a more conservative investor profile (as more of the assets are held by the official sector), with close to 55% of their USD 9 trillion of US exposure in bonds.

China and Japan still have by far the largest US holdings, even though Japan has trimmed its bond holdings in recent years. The raw data suggests China has been a seller of US assets, but it is assumed some of China’s UST holdings are now held in Belgium and Luxembourg, the domicile of Clearstream and Euroclear.

In nominal terms, but particularly in relation to the size of their domestic economies, South Korea and Taiwan now have significant positions in US assets. Korea holds USD 750 billion in US stocks and bonds, 40% of its GDP. Taiwan holds USD 820 billion of US assets, 105% of its GDP. Notably, USD 664 billion of this position is in bonds, which makes Taiwan the largest holder of US bonds in the world relative to the size of its economy. The recent spike in the TWD as investors began to speculate on the repatriation, or at least hedging, of some of this position demonstrates how significant a shift in positioning from Taiwanese investors could be for foreign exchange (FX) markets.

It is also well known that several Asian exporters have been hoarding dollars, as it gave them a higher yield than local currency and, until recently, a weakening JPY and RMB kept their currencies under pressure. With the recent strengthening of the JPY, most Asian currencies including the TWD, KRW, MYR and RMB, started to rise as well. This is likely to trigger significant rebalancing of investor and corporate currency exposure.

Institutional policies

Several narratives and facts are likely to drive a multi-year diversification away from US assets and the dollar.

  • The weaponisation of the US dollar payment system via sanctions is encouraging neutral and non-aligned countries to seek alternatives.
  • Geopolitics: Escalation of conflicts that force the US to spend more on defence (Ukraine, Israel) have been driving central banks to diversify out of US Treasuries.
  • Less open economy: Barriers for trade, education, and immigration – as well as forcing US companies to manufacture in the US – will lead to higher prices and lower margins. Less immigration and more deportations will lead to lower potential growth and add inflationary pressures, particularly for low value-add services, construction, and manufacturing industries. The ongoing struggle with Harvard University is likely to push students towards universities in other countries.
  • Institutions and the rule of law: Trump has threatened to sack Federal Reserve Chair Jerome Powell, has accused large legal firms of being partisan, and has installed close aides across key establishments, including the Supreme Court. Ashmore believes the US institutional decay predates Trump. There has long been a partisan schism leading to a severely dysfunctional Congress, which has been increasingly dominated by interest groups (i.e., lobbyists for various industries such as weapons, pharma, and tech). Congress has become increasingly transactional, leading to a more ineffective government balance.
  • Foreign policy: The current administration’s bashing of key allies such as Europe and opponents like China, means these governments are mobilising to become more self-sufficient. Foreign investors thus have more opportunities to invest at home and to fear a less friendly US administration.
  • Poor infrastructure: Investors betting on another decade of technology stock hegemony are missing a bigger point. There is no AI scaling without a massive increase in energy generation and heavy investment on the energy grid to support transition and distribution. The overload blackouts in Portugal and Spain last month, and the UK paying for energy generation companies to stop producing attractively priced wind renewable energy in the North Sea, shows the world is neither ready for the energy transition nor for an increase in energy demand. The next big equity investment opportunities, therefore, are likely to be in project finance. This is a space where Japan, Germany, and China outperform the US.
  • External imbalances: The US current account deficit, excluding oil, is at a record high of 5% of GDP.
  • Dollar settlement: Since the US is energy self-sufficient, exporting countries’ surplus have relocated to other places such as China, Europe, Japan and India. Even though oil is still priced in dollars, China has been successful at settling oil imports in RMB. This means oil exporters need to make an active decision to invest their surplus in the US. As the US has been actively debasing its currency since the pandemic, reserve managers have been prioritising gold. But the dollar has still been the leading currency for settlement, given the lack of alternatives. Not anymore. The BIS and the BRICS have been working on cryptocurrency projects (mBRIDGE and BRICS Pay) that could bypass the dollar system[1]. BRICS Pay is interesting as it is a crypto currency partially backed by gold and a basked of BRICS currencies, making it a good candidate for settlement and reserve assets.
  • US rebalancing: Imbalances do not mean that things will change. But the US administration is openly very keen to lower the external imbalance of a historical high current account deficit. Scott Bessent, United States Secretary of the Treasury is encouraging Europe and Japan as they implement policies that are leading to a strengthening of their own currencies. This is where the fiscal policy is key. Bessent understands there will be no external rebalancing without an increase in the US savings rates (lower fiscal deficit) and a simultaneous lowering of Chinese and German savings.
  • Foreign rebalancing: The fiscal expansion in Germany guarantees lower savings rates and more recycling of Northern European surplus. China is perhaps waiting for the US to show it is serious about lowering its fiscal deficit before attempting to support more consumption. After all, moving from an export-led to a consumption-led growth model is a major challenge. If the US does not rebalance its fiscal deficits, its external accounts will also remain imbalanced. In this scenario, higher tariffs on China would lead to a lot of re-routing, but China would retain its position as the largest exporter in the world and the US the largest importer, even if the bilateral trade declines.

Correlations breaking down: From the ‘dollar smile’ to the ‘dollar frown’

Another factor that should make it evident the US leadership position is eroding is the breakdown of the ‘dollar smile’ relationship. This elegant and simple model was created by then-Morgan Stanley currency strategist Stephen Jen. He posited that the dollar would strengthen both during periods when the US economy is outperforming the rest of the world, but also during a risk-off recessionary shock. The dollar could only weaken when the rest of the world’s growth was outperforming the US, in a benign macro backdrop.

An analysis of the mechanics of the model explains why it broke down in 2025. Anti-fragile currencies that benefit from recessions are those from countries that are net creditors to the rest of the world, like Switzerland or Japan. In a recession or severe risk-off events, Japanese and Swiss managers are forced to cut risk in their portfolio, which can be achieved either by selling foreign assets to buy local assets or hedging the FX exposure of foreign assets. Both flows drive the CHF and JPY stronger.

The US dollar, however, is a currency of the largest net debtor in the world. The dollar smile only worked since Alain Greenspan’s tenure (when the Fed started to promptly react to market volatility) because foreign investors would buy more ‘risk-off’ US Treasuries than they would sell ‘risk-on’ US equities, leading to an inflow to the US capital account that strengthened the dollar. But with inflation above the Fed’s target and severe question marks posed by tariffs, the Fed is not currently likely to cut rates in response to market volatility.

The simple logic of mean reversion suggests that no trend lasts forever – and the extraordinary outperformance of US equities is no exception. For years, a massive global concentration in US assets has been fuelled by fiscal expansion, pushing the nation’s net international investment liability to an unprecedented 26 trillion.

Since the change in the US administration last November, there have been seen signs of a pivotal shift. Abroad, renewed growth prospects in Germany and China—two of the US’s largest creditors—are creating attractive alternatives for investment. At home, the inevitable focus on reining in the twin deficits threatens to pressure US earnings and the dollar, further encouraging diversification.

This environment creates powerful tailwinds for emerging markets. The sheer scale of global exposure to the US means that even a minor rotation can have a major impact on the comparatively smaller EM capital markets. With their compelling combination of attractive valuations, high real yields, and improving fundamentals, emerging markets are well-positioned to capture the coming wave of inflows from investors seeking value, growth and diversification away from the dollar.

Take the FAAA accredited quiz to earn 0.25 CPD hour:

CPD Quiz

The following CPD quiz is accredited by the FAAA at 0.25 hour.

Legislated CPD Area: General (0.25 hrs)

ASIC Knowledge Requirements: Economic Environment (0.25 hrs)

———

Notes:
[1] https://www.bis.org/about/bisih/topics/cbdc/mcbdc_bridge.htm
Important information: The information included in this article is provided for informational purposes only. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Ashmore Investment Management, PAN-Tribal Asset Management Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.

The post CPD: A multi-year tailwind for EM assets appeared first on AdviserVoice.

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