After years of lagging developed market (DM) returns, emerging market (EM) equities are reasserting their relevance. Energized by a weakening dollar and revised growth estimates, 2025 saw EM equities delivering their best calendar-year performance in nearly a decade. Despite these strong gains, we believe EMs remain significantly undervalued, underscoring the compelling entry point for investors today.¹

In our view, there are three pillars underpinning the opportunity:

• A constructive macroeconomic backdrop: Tailwinds like a weakening dollar and easing global monetary policies are driving EM growth.
• Historically wide valuation discounts: EM equities are trading at levels not seen in decades, offering a rare value proposition.
• A maturing corporate and policy landscape: Structural reforms are finally converting robust GDP growth into tangible earnings gains.

The Winds of Change: Dollar and Policy Trends

While the global macroeconomic backdrop remains rife with uncertainty, two macro levers that have historically influenced EMs are turning supportive. The U.S. dollar—long a headwind for emerging markets—is weakening, and historically, periods of dollar softness have coincided with stronger EM equity and currency performance. With the Federal Reserve shifting into a cutting cycle, marked by three consecutive 25bps rate reductions in late 2025, the dollar’s multi-year bull run appears to be peaking. A softer dollar has historically benefited EM economies due to the strong inverse correlation between the trade-weighted dollar and the relative performance of EM versus DM equities, as illustrated in Exhibit 1. As the dollar declines, the debt load for emerging economies—much of it denominated in U.S. dollars—could ease, creating room for fiscal stimulus and bolstering economic resilience.

Two other factors are also supporting the case for a weaker dollar: High carry makes EM currencies attractive relative to low-yielding developed market peers, and the U.S. dollar—now behaving more cyclically—is likely to weaken as U.S. growth slows. This environment should limit EM currency downside during U.S. growth shocks, while also enhancing their appeal amid stable or improving global risk sentiment.

And while the dollar weakens, the EM/DM growth differential widens. Emerging markets have historically outpaced developed markets in real GDP growth, a trend that looks on pace to continue. The IMF raised its 2025 outlook² for EM and developing economies to 4.2%, reflecting resilient activity and policy credibility improvements across several EMs. In contrast, growth forecasts for DM hover at around 1.6%, with disinflation enabling monetary easing in some advanced economies—conditions that typically support risk assets and EM capital flows.

Valuation Gaps: A Historic Opportunity

EM equities rallied for 10 consecutive months to start 2025, driven by strong earnings growth, optimism around artificial intelligence, and robust foreign investor demand. In September alone, the MSCI Emerging Markets Index rose 7%, buoyed by the Fed’s first rate cut of the year. Beyond the positive macro trends, the valuation story is perhaps the most compelling. For much of the last four decades, EM and DM relative performance has oscillated in long, multi-year cycles, each lasting, on average, nine years. The current EM underperformance cycle, at approximately 13 years, is already notably longer than the historical average, setting the stage for mean reversion. Today, forward P/E spreads show EMs trading at more than one standard deviation below DMs—a valuation gap not seen since the dot-com era and one that has historically preceded strong forward returns (Exhibit 2).

From GDP to EPS: Governance and Fundamentals

A key frustration of the past decade has been the weak translation of EM GDP growth into corporate earnings growth. Weaker corporate governance, poor capital discipline, and deficient shareholder protections have been the primary contributors to muted corporate earnings. However, the earnings drought in emerging markets appears to have bottomed out, with company fundamentals beginning to strengthen. This turnaround can be attributed to recent improvements in corporate governance and financial reforms that focus on greater capital discipline, enhanced shareholder value, investor protections, and information disclosure and transparency.

Seeking to Unlock Alpha: The Role of Active Quantitative Management

The three pillars above suggest a structural shift is underway, one that presents a strategic moment for asset allocators who understand the current investment landscape. Inefficiencies inherent to emerging markets create fertile ground for employing a disciplined, active approach to unlock potential for alpha generation.

While the emerging market indexes offer broad exposure, passive approaches may leave return on the table and add unrewarded risks. Our investment team’s analysis identifies three enduring reasons to go active—and why quantitative processes are particularly well-suited:

1. Capitalizing on Higher Return Dispersion

Emerging markets exhibit far greater stock return variability compared to developed markets, creating a wider spread between winners and losers. This higher return dispersion translates into opportunity: factor-based strategies have historically delivered stronger performance in EM than in developed markets, underscoring the value of disciplined stock selection. An active, quantitative approach can systematically identify and combine these factors into portfolios designed to harness this structural advantage. Over a 10-year period, key active factors—such as Value, Momentum, and Earnings Revisions—generated significantly higher cumulative returns in EM compared to developed markets (Exhibit 3), reinforcing why quantitative strategies thrive in these environments.

2. Navigating Higher Transaction Costs

Passive, index-tracking strategies often face higher transaction costs in emerging markets due to frequent, index-driven trades and less liquid securities. In contrast, systematic active managers can execute trades more strategically, incorporating cost-aware portfolio construction—sequencing trades, using liquidity forecasts, and exploiting information advantages—to offset costs with alpha. This advantage is particularly pronounced in markets with higher fixed costs and wider bid-ask spreads, allowing active managers to preserve returns that would otherwise be eroded by inefficient trading.

3. Mitigating Sector Concentration Risks

Emerging market indexes are prone to significant concentration risk—by sector and by top positions—compared to developed benchmarks. For example, the MSCI Emerging Markets Index is heavily weighted toward Information Technology and Financials, creating vulnerabilities to sector-specific shocks. Systematically constructed portfolios help address sector skews, cap single name exposure, and build diversified, factor-balanced portfolios that seek to preserve upside potential while aiming to mitigate idiosyncratic shocks. Across the universe of investable EM stocks, a systematic approach can simultaneously scale the breadth of research, enforce robust risk controls, incorporate macro sensitive tilts (to currency and interest rates), and harness proven factor premia—critical for investing in a regime defined by dispersion and transition.

Emerging Markets: Activate the Advantage

The confluence of historically attractive valuations, a supportive macro environment, and improving corporate fundamentals has created a powerful investment case for emerging markets. However, the unique characteristics of these markets—higher return dispersion, elevated costs, and concentration risks—necessitate a more nuanced approach than passive allocation alone. An active, systematic approach is critical to navigating the complexities and unlocking the full potential of this compelling opportunity. For investors considering a reset of their EM allocation, we believe now is an opportune moment for activation.