Emerging markets represent 84 per cent of the world’s population and make up 60 per cent of global GDP – and it is not a sector that should be ignored by investors, according to Eastspring Investments’ portfolio manager, Steven Gray.

He says after a very long period of emerging market underperformance, there are encouraging indications of a turning point for emerging markets compared to developed markets. And apart from the numerous opportunities that emerging markets provide for investment returns, they also play an important role in portfolio diversification.

He sees three crucial drivers of emerging market investment performance in 2026.

“The first is US dollar weakness. Over the long term there is a strong inverse correlation between the trade-weighted US dollar and the performance of emerging markets relative to developed markets.

“On a trade weighted basis the US dollar has weakened during the year, and it is not showing signs of strengthening any time soon.

“There's an excellent correlation between emerging market outperformance relative to developed markets and US dollar weakness. Not least because emerging markets have lower US sales revenue exposure (around 13 per cent) compared to Japan and Europe (around 20 per cent), making emerging market earnings less sensitive to a weaker dollar, all else being equal.

“Meanwhile expectations for further US Federal Reserve rate cuts are weighing on the US dollar, and keeping it weak,” he says.

A weaker dollar typically gives central banks in emerging markets room to cut rates, and they are doing so. This is the second driver.

“Emerging markets have considerable scope to cut rates given their well-controlled inflation, historically high market-weighted real interest rates that are around 3 per cent, and their lower debt-to-GDP ratios (compared to developed markets).

“This is important because historically emerging markets have outperformed developed markets during easing cycles - provided global growth is benign, as it is now.”

He says the third important turning point for emerging markets is the performance of China compared to the US, particularly since 2020.

“Whether the very expensive US market can continue to outperform from current levels, despite dollar weakness, is debatable. However, China’s strong performance in 2025 so far bodes well for emerging markets.

“China’s commitment to 5 per cent growth is backed by targeted stimulus -  including expanded fiscal spending, bond issuance, and interest rate cuts, which are aimed at boosting consumption through trade-in programmes, social subsidies, and sector-specific lending.

“In addition, Chinese households are sitting on $US22 trillion in deposits which could be a powerful catalyst for spending and hence growth if confidence returns.

“Also positive is the message from China that the era of heavy-handed intervention into the private sector economy is over.

“When you combine this change in government attitude with developments such as DeepSeek, which has invigorated the technology sector, the diminishing impact of the drag from the property sector, as well as initiatives such as the anti-involution policy,  it may all lead to a better focus on returns.

“There are definite legs to the story that China can remain strong – but perhaps most importantly, China doesn't need to outperform, it just needs to stop being a drag for emerging markets so that overall emerging markets can have a better chance of outperforming relative to developed markets.”

He says it is clear that emerging markets present one of the most compelling opportunities to outperform developed markets in over 15 years.

And within emerging markets, he adds the case for an emerging market value investment style is even stronger.

“Historically, emerging market value has outperformed the broader emerging market index during periods of emerging market outperformance when compared to developed markets (and vice versa). The only exception being during Covid-19 when emerging market value massively underperformed during the initial shock of lockdowns, but subsequently rebounded off a very low base.

“To a large extent, emerging market value magnifies the issues and opportunities of emerging market investment. When emerging markets are unloved, investors tend to crowd into a few popular sectors with stronger long-term growth and higher quality factors. As a result, the valuation dispersion, measured as the price-to-earnings ratio of the most expensive quartile of stocks over the least expensive quartile, increases.

“But when investor interest returns to emerging markets, valuation gaps typically narrow. So if emerging markets were to start outperforming relative to developed markets, I think the cheaper part of that, which is the emerging market value, could outperform even more,” he says.