Emerging markets have enjoyed a good 2025 so far, but these higher-risk geographies have heavily lagged their developed counterparts over the long term. Hyped-up opportunities in nations from Brazil to China have often ended in disappointment – how should investors factor in this year’s rally?

In sterling terms, the MSCI EM index delivered a net return of 10 per cent to the end of August. That was double the 5 per cent return for the developed market focused MSCI World index.

While emerging markets are often pointed to as an opportunity for diversification and growth, with their generally better demographics and more rapid economic expansion, the trend of long-term developed market outperformance was accelerated post-pandemic given the attraction of US tech stocks.

Yet Bank of America’s August global fund manager survey flagged that managers were 37 per cent overweight emerging market equities, the highest level since February 2023. A record 91 per cent of managers said US equities were overvalued.

Strategists at BlackRock pointed this week to three key drivers which have increased the attractiveness of emerging markets: a weaker US dollar, an improved macroeconomic backdrop and “mega forces” such as the semiconductor production market in Taiwan and South Korea and Chile and Peru’s position in critical minerals.

The 10 per cent fall in the US dollar this year against a basket of foreign currencies, on concerns about the potential end of American economic and trade dominance, is the most important theme here. Emerging markets’ exposure to US-denominated debt means repayments are easier with a weaker greenback, while exports are supported. This strengthens earnings and valuations.

From a diversification perspective, emerging markets should play some part in a portfolio given market characteristics and their material importance to the global economy. Our four Alpha tactical asset allocation portfolios have between a 5 and 9 per cent allocation to the MSCI EM index.

However, simply owning the EM index through an exchange traded fund rather than being selective does come with certain considerations. The MSCI EM index is dominated by a handful of markets. Chinese equities take almost a third of the index, Taiwan is on 19 per cent, India on 16 per cent and South Korea on 10 per cent. That means heavy exposure to Asia.

AI chipmaker Taiwan Semiconductor Manufacturing Company (TW:2330), which we have flagged as a value play, makes up a huge 10.3 per cent of the index. That is almost double the weighting of second-largest stock, Chinese social media and online services business Tencent (HK:700).

The index’s performance obscures vastly different outcomes across key markets and presents some big investment decisions.

For example, how to approach China and India which have had starkly different performances this year. China has rebounded and driven the emerging markets performance this year, while India has struggled amid 50 per cent US tariffs and concerns about elevated valuations.

This highlights that, as with opportunities in developed markets, selectivity is important in emerging geographies.

The IC’s Val Cipriani picked out Ashoka India Equity (AIE) as a standout investment trust option in India. Dave Baxter flagged Invesco Global Emerging Markets (GB00BJ04FP47), which has delivered a double-digit return this year and has lower exposure to China than the index.

BlackRock’s strategists, while broadly neutral on emerging market equities, pointed to India’s young population and progress with digitisation as an opportunity. They also argued that it’s a good moment to “lock in yields in local-currency bonds in Hungary, the Czech Republic, South Africa, Brazil, Mexico and Colombia”.

For investors prepared to deal with the volatility of emerging markets, they trade at a wide discount. The MSCI EM trades on 13 times forward earnings, a 35 per cent discount to the MSCI World.