Emerging markets equities are experiencing a period of renewed strength. After years of lagging developed markets, they are on course for a second consecutive year of relative outperformance in 2026. Valuations remain comparatively attractive, raising the question of whether the recovery could develop into a more sustained cycle.
However, the emerging markets investment landscape has changed considerably. The growth of artificial intelligence has increased the importance of semiconductor manufacturers in Asia, while demand for energy and industrial metals is creating new opportunities for commodity-exporting countries. At the same time, currency movements and monetary policy remain important influences on relative market performance.
For institutional investors, these developments highlight two distinct challenges: determining where to allocate within emerging markets and identifying sources of return beyond conventional stock selection.
Three Forces Shaping Emerging Markets
According to Justin Kariya, Head of Macro Strategy at City of London Investment Management (CLIM), three factors are particularly important for the emerging markets outlook: AI hardware demand, the direction of the US dollar and the potential for a broader commodity cycle.
Artificial intelligence has become a significant driver of emerging markets earnings, particularly in Taiwan and South Korea. Both markets are closely connected to the global semiconductor supply chain, with companies benefiting from investment in data centres, computing infrastructure and memory.
Export orders from Taiwan and South Korea, which historically have provided useful leading indicators for emerging markets earnings, continue to show strong momentum. Although the sustainability of AI-related capital expenditure remains a subject of debate, current indicators point to continued demand.
“In terms of where we are right now, the data is still accelerating so the fundamentals are strong and improving,” says Kariya.
The second factor is the US dollar. Historically, emerging markets equities have tended to perform better relative to US equities during periods of dollar weakness, as currency movements influence financial conditions, capital flows and investment returns.
Recent dollar strength has therefore introduced a potential headwind. Nevertheless, Kariya distinguishes between the appreciation reflected in widely followed dollar indices and the broader performance of emerging markets currencies. While the dollar has strengthened against the euro, currencies including the Brazilian real and Chinese renminbi have demonstrated greater resilience.
A more prolonged US monetary tightening cycle, accompanied by broad-based dollar appreciation, would represent a significant risk to the emerging markets outlook.
The third driver is commodities. Investment in AI infrastructure, electricity grids and electrification is increasing demand for industrial materials, including copper, alongside growing energy requirements. This could provide longer-term support for commodity exporters, particularly in Latin America.
CLIM currently identifies opportunities in markets including Mexico and Chile and has recently become more positive on Brazil. In Asia, Taiwan and South Korea remain important beneficiaries of technology investment, while China A-shares offer exposure to the development of China’s domestic AI ecosystem.
These differing dynamics reinforce the importance of active country allocation. Emerging markets cannot be treated as a homogeneous asset class, with investment opportunities increasingly shaped by distinct economic and structural developments.
From Country Allocation to Investment Implementation
Identifying attractive countries, however, does not automatically determine how investors should obtain exposure to them.
Traditional emerging markets managers typically seek to outperform through fundamental company research and individual stock selection. While these approaches can be effective, combining several managers does not necessarily provide substantially different sources of alpha if their investment processes rely on similar drivers.
CLIM follows a different approach, combining top-down country allocation with investments in listed closed-end funds (CEFs).
Its macroeconomic research covers 29 emerging and frontier markets, assessing economic, market and political factors to identify potential country overweights and underweights. Portfolio managers then seek suitable investment vehicles to implement these views, considering the quality of underlying managers, portfolio exposures, liquidity and valuation.
The key distinction is that the valuation of a closed-end fund can create an investment opportunity independently of the performance of its underlying securities.
Closed-End Funds: Capturing Value Beyond the Underlying Portfolio
Unlike open-ended investment funds, closed-end funds have a fixed number of shares that trade on a stock exchange. Their market prices are determined by supply and demand and can therefore differ from the net asset value (NAV) of the underlying investments.
A fund trading below its NAV is said to trade at a discount. Crucially, this discount is not necessarily constant: it can widen or narrow as investor sentiment, demand and market conditions change.
For investors able to assess these movements, discount volatility can represent an additional source of return.
Consider a closed-end fund trading at a 12% discount to its underlying asset value. If an investor purchases the fund and subsequently sells it when the discount has narrowed to 7%, the change in valuation generates an additional return contribution beyond the performance of the underlying portfolio. With an unchanged NAV, this particular move would produce a price gain of approximately 5.7%, before costs.
Oliver Marschner, Head of Emerging Markets Equity at CLIM, describes the principle succinctly: “It’s really that change over time that we look to take advantage of.”
One example is the Templeton Emerging Markets Investment Trust, a London-listed closed-end fund investing across emerging markets. Its discount to NAV has fluctuated considerably over time, creating opportunities to increase exposure when discounts are unusually wide and reduce positions when they narrow.
Importantly, these inefficiencies can persist even when the underlying securities are liquid and NAVs are regularly published.
According to CLIM’s estimates, investors who are relatively insensitive to discounts account for more than 90% of ownership across the broader closed-end fund universe. These include retail investors, wealth managers and investment vehicles whose transactions may be driven primarily by cash flows, income requirements or demand for particular market exposures rather than the relationship between share prices and NAVs.
However, discount capture is not risk-free. Discounts can widen further, remain elevated for extended periods or reflect genuine concerns about a fund’s underlying portfolio, governance or liquidity. A disciplined assessment of the investment vehicle and its underlying assets is therefore essential.
A Different Source of Alpha Within an EM Allocation
The potential relevance of this approach becomes particularly apparent when considering portfolio diversification.
A conventional emerging markets equity manager and a CEF-based manager may ultimately provide exposure to many of the same companies. The difference lies in how they seek to generate excess returns.
CLIM’s Emerging World Fund, an Irish UCITS strategy, typically invests in a diversified portfolio of closed-end funds managed by established investment firms. As of 30 September 2026, the portfolio held 41 positions, providing indirect exposure to a broad universe of emerging markets equities.
Its largest underlying company exposures included Taiwan Semiconductor Manufacturing Company, Samsung Electronics, SK hynix and Tencent, reflecting many of the securities that also feature prominently in conventional emerging markets portfolios.
The underlying equity exposure may therefore overlap considerably with that of conventional emerging markets managers. What differs is the way the strategy seeks to generate excess returns.
For investors combining several emerging markets managers, this distinction matters. While traditional active managers typically rely heavily on individual stock selection, CLIM seeks to capture additional returns through country allocation, underlying manager performance and changes in closed-end fund discounts.
The strategy can therefore provide diversification in the sources of alpha within an emerging markets allocation, rather than fundamentally different exposure to the asset class.
Historical attribution illustrates the potential significance of discount capture. Over the ten years to 30 September 2026, discount movements contributed an estimated 1.22 percentage points annually to the Emerging World Fund’s relative performance against its benchmark, the S&P Emerging Frontier Super Composite Net Total Return BMI (S&P Super BMI). Over the same period, country allocation and underlying NAV performance each contributed 0.46 percentage points annually, before fees and expenses.[1]
These contributions can vary considerably across market environments. Over the latest one-year period, discount movements detracted 0.61 percentage points from relative performance, while country allocation and underlying NAV performance made positive contributions.
The figures illustrate both the potential contribution of discount capture to long-term performance and the fact that it does not consistently generate positive returns.
For institutional investors evaluating their emerging markets allocations, the question may therefore extend beyond which countries, sectors or managers are best positioned to outperform. It may also be worth examining whether different investment approaches can introduce genuinely complementary sources of alpha.
[1] Source: City of London Investment Management (CLIM)
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