For many years, emerging markets have been traded as a macroeconomic asset class, a leveraged expression of the dollar cycle, domestic growth and external balances (we discuss this below). 10 rules for country selection in emerging markets). Today the EM stock index looks very different. It is increasingly dominated by just a few mega-cap technology firms, whose fortunes depend more on AI investments and global supply chains than on traditional emerging market macroeconomic drivers.
Yet many global allocators still view emerging markets as a macroeconomic asset class tied to currencies, domestic growth and external balances. This creates a growing disconnect: in its current form, the EM index increasingly acts as an indirect play on global technology investments and US-led AI investments.
As a result, investors in search of to diversify away from US equities may not achieve the intended result from passive EM exposure alone. In addition, research from Arslanalp et al. (IMF, 2020) highlights that benchmark-driven allocations can increase the role of external aspects on the expense of domestic fundamentals, thereby increasing the danger of capital flows that usually are not linked to local economic conditions.
For allocators who want to specific macro views, a more targeted approach could also be required. In this context, lively strategies offer the pliability to align portfolios with the underlying macro drivers relatively than the backward-looking composition of the index.
