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Emerging Markets’ Shifting Bottom Line

Since the 2008 financial crisis, many emerging-market governments have gradually been building up resilience to external shocks and domestic volatility. For global investors, that means reconsidering many longstanding assumptions about emerging markets, while also assessing the new risks.

LONDON – One truism of the last three decades is that emerging markets are a leveraged play on global growth: they outperform when developed economies are growing, but they are susceptible to sharp downturns when global conditions are less favorable. This more or less remains true. But when considering emerging-market investment opportunities in the years ahead, one must also understand the changes that have followed developed-market financial crises and a larger shift in the geopolitical landscape.

On one hand, many emerging economies have become more resilient and are no longer simply riding on developed markets’ coattails. On the other hand, juxtaposed against these positive developments are a fresh set of challenges, namely increasingly pro-cyclical liquidity provision by market makers, the rise of populism, and a temptation to rely on currency depreciation as a substitute for structural reforms.

In light of these new realities, the sell-off of emerging-market assets this year actually means that value and risks are better aligned. To be sure, the many risks facing emerging markets still call for a highly differentiated stance, as market illiquidity can magnify the impact of shocks on prices. Yet, in addition to higher yields, three secular trends underpin the case for investing in emerging markets across global business cycles.

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