Han Dieperink: Emerging markets call for selectivity
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
For the first time in years, emerging markets have been outperforming the developed world since 2025. This followed a long period of underperformance. Growth in China slowed, commodities were cheap, and large amounts of investment capital flowed into the United States.
Added to this was the fact that the major US technology companies were gaining an increasingly significant weighting in global stock market indices. Investors therefore almost automatically opted for US shares. However, anyone buying a broad index fund in emerging markets often believes they are investing in young, fast-growing economies. In reality, they are primarily acquiring a large position in a small number of Asian technology companies.
The weight of chips
Almost three-quarters of the returns come from two countries: South Korea and Taiwan. And within those countries, a large proportion of the profits comes from just a few chip manufacturers. TSMC, Samsung and SK Hynix are benefiting greatly from the massive investments in data centres and artificial intelligence. This year, the major US tech companies are collectively spending hundreds of billions of dollars on new infrastructure. A substantial portion of that money ultimately ends up with the Asian companies that supply the chips.
As a result, these companies’ profits have risen sharply. Samsung could potentially see its operating profit increase nearly sixfold this year, to around $185 billion. The three major East Asian chip companies now earn more collectively than Apple, Amazon and Alphabet combined.
As a result, the emerging markets index has become highly concentrated. TSMC, for example, is larger than all Indian shares combined and is held in more than 90 per cent of equity funds worldwide. In the emerging markets index, the technology sector carries even greater weight than in the developed world. Seven of the ten largest shares in the developed world are tech companies.
Emerging or not?
The term ‘emerging markets’ therefore paints a distorted picture. This is particularly true of South Korea and Taiwan. Both countries are still regarded as emerging markets, whilst economically they are closer to the developed world. Per capita income exceeds $35,000 and both countries invest heavily in research and development. Their strong position in the chip industry is a consequence of this.
They also face problems typical of wealthy countries. Their populations are ageing, household debt is high and domestic demand is barely growing. The semiconductor industry cannot fully compensate for this. It is therefore sensible not to view emerging markets as a single entity. South Korea and Taiwan are very different markets from, for example, Vietnam or countries in Latin America. And bonds from emerging markets have their own risk profile. Anyone who puts everything into a single index ends up with the average of all those different markets.
Low valuations and faster growth
Emerging markets are still around 40 per cent cheaper than developed markets, measured by the expected price-to-earnings ratio. Including the technology sector, that ratio is even below ten. Since 2014, this has been roughly the lower end of the range. At the same time, earnings are growing faster than share prices are rising.
And this is despite the fact that emerging economies are growing at a structurally faster rate. Over the past fifteen years, their growth has averaged almost two percentage points per year higher than in the developed world. Moreover, this growth is not accompanied by a sharp rise in debt. Public debt averages around 70 per cent of GDP, compared with over 100 per cent in developed countries. This translates into better credit ratings. For the third year running, there have been more upgrades than downgrades.
This is particularly interesting in the case of bonds. Many central banks in emerging markets raised their interest rates as early as 2021, when rates in the West were still hovering around 0 per cent. As a result, several countries now offer relatively high real interest rates. Moreover, should growth slow, they have scope to cut interest rates.
Improved relations with shareholders
Another positive development is that corporate governance is improving in some countries. South Korea is a good example of this. Since early 2024, a programme has been in place that encourages companies to make better use of their capital, pay out higher dividends and buy back their own shares. It is also enshrined in law that directors must take small shareholders into account. A large part of the low valuation of Korean shares was precisely linked to the way in which companies managed their capital. If this improves, the current valuation of 5.5 times earnings could rise in the long term. The first results are already visible; Japan has undergone a similar transformation.
In the United States, however, we are seeing the opposite in some respects. Founders retain a great deal of power through shares with extra voting rights, and a small group of very large tech companies is increasingly dominating the index.
Underweighted out of habit
Despite all this, many investors allocate little to emerging markets. On average, pension funds have around 5 per cent of their assets invested there, whilst these markets account for approximately 11 per cent of the global equity index. For bonds, the underweighting is even greater, often amounting to just 1 per cent to 3 per cent.
This is partly understandable. For fifteen years, investors have been rewarded for their preference for US equities. But that preference has become so pronounced that it is influencing valuations and portfolio diversification. The question is therefore not only whether emerging markets are attractive, but also to what extent the current preference for the United States is still justified.
Artificial intelligence also plays a role here. In wealthy countries, it is estimated that over 14 per cent of jobs could be automated, compared with less than 5 per cent in developing economies. At the same time, these countries stand to benefit from simple AI applications that make less experienced workers more productive. This does not always require expensive data centres.
Look at the differences
The strong performance of emerging markets therefore paints a somewhat misleading picture. Investors using a broad index fund will mainly hold a large position in Taiwan and South Korea, and thus in global demand for chips. Beneath this, however, lie markets that are barely visible in the average: undervalued, growing faster and with central banks that have more room for manoeuvre.
The opportunity therefore lies not in simply increasing a broad index position, but in distinguishing between countries, sectors and asset classes. After a decade in which investors flocked to US shares, it is worth taking another look at emerging markets. In doing so, pay particular attention to the differences, not the similarities.