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By Molly O’Connor, International Banker
In one of the most remarkable reversals observed across global financial markets in 2025, emerging markets (EMs) turned around a decade of consistent underperformance to register an indisputably stellar year. Multiple asset classes, including equities, bonds and currencies, achieved exceptional returns across many EM economies, with EMs’ benchmarks also frequently outpacing those of comparable developed markets by hefty margins. What’s more, the persistence of several drivers behind this recent surge, ranging from a weaker US dollar and solid EM business fundamentals to prudent monetary policy and encouraging structural reforms, is boding well for the allocation of EMs in global portfolios in 2026.
Indeed, this resurgence follows many years of EMs’ equity and debt returns lagging their developed-market peers, as headwinds—including China’s steady economic slowdown to around 6-8 percent annual growth during the 2010s, from the double digits it often registered the previous decade; tightening dollar conditions; and a growing preference for safe-haven assets—weighed on the sector’s performance. And yet the MSCI Emerging Markets Index returned 25.1 percent last year in a spectacular turn of events. Morningstar also reported in October that Europe-domiciled global EM equity funds recorded “their best quarter in terms of net inflows since the first quarter of 2023, with €9.1 billion taken between July and September”.
Dollar weakness explains a fair chunk of this trend reversal. One of the most persistent themes of 2025 was that the greenback’s depreciation enabled dollar-denominated returns in EM assets to strengthen markedly, with the Brazilian real, Mexican peso, Chilean peso and South African rand achieving some of the most pronounced gains. In turn, the appeal of local-currency equities and bonds grew for global investors, whilst easing debt-servicing costs for EM companies and governments with significant US-currency liabilities instilled further confidence in EM equity and credit markets.
Improvements in corporate earnings across many EM regions also supported equity returns, with earnings per share (EPS) emerging from flat or negative growth in prior years, particularly as domestic demand recovered faster than expected in Turkey, Brazil, parts of Southeast Asia and other regions. This allowed EMs to attract tens of billions of dollars in net investments throughout the year.
After years of consistent US-equity bullishness, moreover, global investors entered 2025 with limited EM exposures. By then, EM companies were experiencing significant valuation gaps relative to their developed-market peers, and EM equities and bonds were more attractively priced than they had been for several years. “Emerging markets are well-positioned to benefit from a rotation out of US assets given their strong fundamentals and attractive valuations,” Schroders noted in late May. “Unlike the vulnerabilities plaguing the US, many emerging economies are robust. They feature healthy external balances, manageable debt levels, high real interest rates, and undervalued currencies.”
Those “high real interest rates” have proven especially appealing to EM bond investors. “Worries about rising inflation and debt levels in the US prompted investors to consider the diversification benefits of non-US dollar assets, raising the appeal for EM local bonds, but that’s only half of the story,” VanEck explained in December. “On top of that, sovereign bond yields in EM countries remain high, as many EM central banks started tightening in 2021 well ahead of advanced economies, front-loading hikes to contain post-pandemic inflation. The result has been high real yields, which continue to be an important driver of return.”
With China’s gross domestic product (GDP) still growing at a comfortable 5 percent in 2025, despite weak domestic consumption and property investment triggering a slowdown in the final quarter to 4.5 percent, some analysts noted EMs being buoyed by a more upbeat outlook for the Asian superpower. “Investors across the region have welcomed the Chinese authorities’ efforts to boost consumer confidence and support the country’s ailing property sector through lower interest rates and a series of domestic stimulus initiatives,” J.P. Morgan Asset Management wrote on December 1. “In addition, US trade policy has prompted a wave of Chinese domestic investment as local manufacturers try to meet demand for tech components and other inputs previously sourced in the US.”
On the policy side, meanwhile, reform-oriented fiscal economics—including subsidy reforms in Nigeria and International Monetary Fund (IMF)-supported structural adjustments in Egypt—helped to stabilise growth and thus boost investor confidence in some EM economies. Some also benefited from cyclical gains in various commodity prices, which supported export revenues and government fiscal positions, particularly in Latin America during the second half of the year. Brazil, for example, saw higher iron-ore and agricultural export revenues bolster its trade balance and underpin a stronger fiscal position, while Chile benefited from firmer copper prices, which lifted export earnings and improved public finances in a country heavily reliant on copper revenues as a major source of government revenue.
Looking ahead, many wonder whether last year’s EM outperformance can be repeated in 2026.
Looking ahead, many wonder whether last year’s EM outperformance can be repeated in 2026. According to Delphos, the macroeconomic backdrop for the sector this year will feature falling global rates and strong, “unique” growth stories. “This combination of solid growth and easing inflation creates a favourable environment for fixed income and equity investments,” the financial advisory and capital-raising firm recently wrote. “Capital flows into EMs are expected to stay positive, supported by favourable external financing.”
At this early stage of the year, a relative slowing of growth in developed economies, coupled with the ongoing reallocation of global investors’ capital towards assets outside the United States, could well prolong the window of opportunity in EMs over the coming months. Indeed, consensus forecasts project that many EM economies will continue to expand at rates above those in advanced economies. For example, the International Monetary Fund has forecast that emerging markets and developing economies will lead global economic growth at 4 percent this year, versus 1.6 percent for advanced economies.
Should the US dollar remain weak—or continue to moderate from its strong highs earlier in the decade—EM local-currency assets will retain one of their key supportive factors. Conversely, if US monetary policy surprises on the more hawkish side, EM currency and bond markets may face renewed pressure and/or become more volatile, which could directly weigh on returns for dollar-based investors. Countries with flexible exchange-rate regimes and strong foreign exchange (FX) reserves, such as Brazil and South Africa, may be better positioned to manage external shocks, while those EMs with less pronounced currency debt obligations will be able to manage any undue stress should the global monetary environment tighten.
And what about India, arguably the brightest economic growth hope of all major EM economies? Indian equities underperformed other EM peers in 2025, with the MSCI India Index delivering modest returns of around 4 percent in US dollar terms. A weaker rupee, underperforming corporate earnings, soaring US tariff rates and relatively high local interest rates tempered foreign investors’ enthusiasm, despite the country’s strong broader growth fundamentals.
Nonetheless, resilient domestic demand and demographic advantages should continue to position India for sustained above-average growth, both in 2026 and beyond, despite last year’s subdued equity performance. India’s structural underweight in global portfolios—last year saw foreign investors pull out a record $18 billion from the country and push foreign ownership of Indian equities to a 15-year low of roughly 16.9 percent—could lay the foundations for a potential rebound in inflows should earnings growth accelerate meaningfully this year.
As for Asian export hubs such as South Korea and Taiwan, which have forged deep ties to semiconductor and high-technology manufacturing, this particular EM segment could reap considerable windfalls from the global demand growth expected this year in artificial intelligence (AI), cloud infrastructure and electrification supply chains. EM equity flows tied to these sectors could further strengthen if global development in these technologies remains a central investment narrative.
Should prices for key energy, metal and agricultural markets stay elevated this year, those commodity-exporting EMs, including Brazil, Chile and Middle Eastern economies, should prosper, and even more so if demand from China stabilises. Fiscal positions in such economies typically improve with stronger export revenues, thereby reinforcing sovereign-credit profiles and reducing debt-related risks.
“The market environment will be shaped by uneven sector performance, with some sectors vulnerable to trade tensions and geopolitical risks,” Delphos also cautioned, acknowledging that narrowing risk premiums are reflecting improved investor sentiment for EMs. “Capital allocators should focus on markets with credible policy anchors and improving fiscal positions.”