Hello and welcome back to the Institutional Beat Podcast, where we discuss interesting and relevant topics for institutional investors. My name is Dylan Rae, and I'm a portfolio manager on the PH&N Institutional team. I'll be your host on today's episode. Today, we are going to dive into the topic of emerging market (EM) equities, which to the surprise of many investors, have been a standout performer this year with the broad-based emerging markets equities index, besting both the U.S. and global developed market equity indices by a wide margin.

As our listeners will know, RBC GAM has multiple investment teams around the world managing a full spectrum of asset classes, including emerging market equities. And within our firm, there is no one better placed to discuss what's happening in emerging markets than my colleague and friend, Dijana Jelic.

Dijana is a member of RBC GAM-UK's emerging markets equity team, and she is joining us today from London, England. Dijana, thank you so much for making time for us today. And welcome to the Institutional Beat.

Hi. Great to be here, Dylan.

Great. I started the episode by focusing on performance, so let's dive into that first. Could you walk us through how emerging market equities have performed so far this year, and shed some light on the key factors that are driving this performance?

Yes, sure. So as you mentioned, Dylan, you know, what we've seen this year has been quite notable. There's been a significant reversal in equity market leadership away from the U.S. and into non-U.S. assets, particularly emerging markets. So, if we look at the performance for the first half of this year, EM equities have actually outperformed the S&P by almost 10% in U.S. dollar terms.

And you know, when we look at what the trigger of this has been, I think the main trigger has really been the fact that we've seen elevated trade and economic policy uncertainty coming from the U.S. And that's really coincided by significant U.S. dollar weakness. So after about 13 years of a very strong U.S. dollar bull market, we've actually seen the U.S. dollar have its worst performance for the first half of the year in over 50 years.

So it's fallen by about 10%, as of June. And I think what's really telling, when you look at the U.S. dollar performance, is that it failed to rally on a risk-off move, which actually was the announcement of those Liberation Day tariffs back in April. And that's the first time that it's failed to do so since 1987 with the Wall Street stock market crash.

So, yeah, some really significant developments so far this year. Now, if we just dive deeper into EM equity performance, I think one positive is that performance is really broadening out. The asset class has performed very strongly as a whole, but it's really been driven by many different markets, many different drivers. So, you have the tech-driven markets of Korea and Taiwan once again taking the lead in Q2.

Also, positive political developments have been drivers behind a number of markets. So South Korea, where we've seen the removal of political gridlock, but also Brazil and the Latin America region in general. In terms of sectors, IT, as we've seen globally, has once again been the outperformer over the last quarter. And also Financials, it’s an area that we really like, it’s had a couple of years where its performance has been quite challenged, but this year, once again, we've started to see really strong performance from Financials. And we think the outlook looks really strong from here.

Great. So you mentioned the dreaded “T” word, or tariffs. Many of the Trump administration's most notable targets of course, have been EM countries. And I'm thinking China, Mexico, India, and South Africa in particular. Can you share your current assessment of the impact of tariffs on emerging markets, and maybe highlight where your assessment perhaps differs from the market's current expectations for the impact of tariffs, and deglobalization more broadly?

Yeah, sure. Clearly the picture is still very uncertain. We don't really know exactly where, you know, the tariff rates will end up for each market. But I think when we look at what's been happening over the last few months since Liberation Day, I think our main concern from an EM equity standpoint was China.

You know, we felt that there was a risk that that Trump would move from really targeting all countries to looking to isolate China. But actually now we feel that it's looking increasingly likely that a deal between the U.S. and China will be struck, as China is really shown its strength, I'd say. And I think the U.S. perhaps underestimated its reliance on China, both in terms of things like rare earths, but also other exports and also the fact that actually, when you look at what's been happening with China tech innovation, for example, DeepSeek, I think the U.S. is starting to question whether clamping down on China's access to some of the higher-end chips was actually, you know, a positive move or whether it actually really backfired and caused China to innovate and progress even faster.

So, yeah, those are just some initial remarks. But I'd say generally, if you take a step back and look at the exposure of emerging markets to the U.S., actually we feel quite comforted to see that actually for most EM economies, the exposure is quite low.

So if you look at, for example, the U.S. as a portion of total exports or its a portion of total GDP, it’s kind of in the low double digits or even single digits for most economies. I think Mexico would be the one exception, where it's really relying on U.S. exports – over 80% of its exports go to the U.S.

But actually overall, we actually feel that Mexico is in quite a strong position currently. We feel Sheinbaum, the president, has been able to negotiate and navigate Trump quite well. And we generally feel that LatAm (Latin America) as a region could come out fairly strong relative to other markets in this environment. And I think the longer-term picture, which is probably the most important, is a decoupling of the EM trade.

So we're increasingly starting to see that emerging markets are trading more and more with one another. As of today, almost 50% of all EM exports actually go to other EM economies. And considering that's really where the growth is in terms of consumption, in terms of the economy, we actually think that that's really beneficial for the region as a whole.

So that's an excellent setup for where I want to go to next, which is looking at the outlook for emerging markets. As noted earlier, emerging markets have been surging this year, significantly outpacing their developed market counterparts. Many investors and ourselves included here have been optimistic that emerging markets will regain their leadership over developed markets over a sustained period of time, just given the strong underlying fundamentals that underpin EM.

Can you take us through this thesis at a high level and update us on your team’s current outlook for emerging market equities?

So, yeah, I think as you mentioned, Dylan, we've been talking about this for a long time and observing the fact that fundamentals have been turning in EM's favour for a number of years. But actually, what we're starting to see now and more and more investors are really asking the question, is: Are we actually now at a turning point? Is Trump really the trigger to see this regime change?

So if we take a step back and we look at equity market performance, what we can see is the relative performance of EM and DM equities moves in very long cycles. So going back to kind of 1990 – so, in 35 years – we've seen really two long cycles where EM has outperformed, and then two long periods where EM has underperformed including the last kind of 12, 13, 14 years.

And when we look at the factors that have been driving these relative cycles, there's a couple that really stand out. I'd say first of all, the U.S. dollar. There's a strong negative correlation between the U.S. dollar and the relative performance of EM equities, and then also relative GDP growth, and relative earnings. And all of those are now turning in EM’s favour.

So the U.S. dollar has really been I guess, the final domino to fall. So increasingly investors are really asking the same question – and we really feel the question is, whether U.S. dollar weakness is now structural. We think there's a strong case to argue that that is the case. For example, if you first think about Trump himself, his policy actually wants a weaker U.S. dollar.

Secondly, we have very large twin deficits in the U.S., large current account fiscal deficits. And ultimately, we think after a very strong dollar bull market, valuations, despite the recent weakness, actually look extremely stretched for the U.S. dollar. So there is actually still some way to go, particularly considering investors’ overexposure to the U.S. dollar in U.S. assets.

I'd say in terms of the other factors I mentioned, so GDP growth. So, what is clearly one of the reasons why people invest in emerging markets is the stronger growth. And indeed, EM accounts for about two-thirds of global GDP growth. But it's really been that differential between EM and DM GDP growth that has really determined that relative equity performance, as what we've seen is over the last decade, that differential has narrowed.

But again, that's really widening in emerging markets’ favour. It's really expanding. So it's no longer just you know, a China story. We have India, we have Southeast Asia, we have the Middle East. Many different drivers and many different factors really contributing to that strong GDP growth. Finally, earnings. Earnings have been cyclically weak in emerging markets for a number of years.

But again, we're really starting to see a pick-up again, really supporting the case that we are now at the beginning of a turning point which should favour emerging market equities.

So you've covered quite a lot there in terms of countries and markets and different sectors. That actually brings me perfectly the next question, which is just to take a moment to think about what's on your team's agenda. Very vast scope – perhaps of all the investment teams we talked to, yours has probably the widest scope in terms of what you cover.

So 24 countries, representing more than half the world's population. Certainly more than half in terms of the economic growth and contribution to GDP. And well over 1,400 potential companies to invest in. So it's always fascinating to hear what's on your and the team's agenda in terms of research and travel plans. Any notable trips or research updates you think would be interesting, to our listeners to sort of know where you're focused on at the moment.

Yes. As you know, Dylan, our team is very centralized. We all sit together in very close proximity in London, which is really a hub for EM investing. So, if you looked at our calendar, there's not many days where an EM corporate isn't traveling through. But you're right, traveling to the regions is really important.

We do a lot of on the ground research. In terms of what we've been doing this year, I can highlight maybe, at the beginning of this year and the end of last year, we did a couple of trips in Latin America. We visited Chile, Argentina, Mexico. And I think it's a really interesting region. It's one where we found that politics can make a material difference in terms of how we invest and the share price performance.

And what we've seen is these quite aggressive shifts in terms of politics, where we've had phases of left wing governments and then phases where it's been more market friendly, more centrist governments. And I’d say, over the last couple of years, it's been quite a challenged environment. It's very much been focused a more left-wing policies, more populist leaders.

But that's really now changing. There's a lot of elections coming up. So Chile this year, Colombia, Peru. Next year, it's Brazil. And the expectation is that we will once again shift more to the kind of centrist side of politics, and that should be really beneficial for these markets. And we've actually started to look for opportunities to add to our exposure, the markets themselves have started to do a lot better as a result.

And then maybe just to mention Taiwan, Korea, we visited both markets in March, very much tech-driven markets, Taiwan in particular. I think one of the interesting things about Taiwan is if you look at the profitability of MSCI Taiwan, it's really very steadily increased through the years. And really a big part of that is tech.

I mean, the majority of the Taiwanese market cap is tech driven. And these are corporates that have really moved up the value-add chain. Really strong focus in R&D innovation. And they're really strong players in terms of AI, but really trading at a fraction of the valuation of the U.S. companies. So it's a market that we really like, but we did start to take some profits as, in EM it did start to do very well, and we have some concerns about the amount of CapEx going into AI, particularly from the U.S. hyperscalers.

Great, thank you. Very interesting as always to hear with what's on your wide agenda. I want to end here just with what we're hearing from our investors on the topic of emerging market equities. One of the questions we've been getting recently, is whether investors can capture the growth in emerging markets through their global equity managers, many of whom hold a small allocation to some particularly global companies, or whether they should continue to maintain a standalone emerging market equity allocation.

What are your thoughts on this? And maybe if I asked in a different way, what would you potentially lose or what are investors potentially giving up, by relying on their developed market managers to have some exposure to emerging markets?

Yeah. I think it's a really, really interesting question. And actually, anecdotally, Dylan, I've been with the team now for almost eight years and what's interesting is it's definitely been the busiest start to the year in terms of marketing activity. So we've had really strong inflows this year, and I think what's particularly notable is that it's no longer just about replacement opportunities, but we're starting to see investors move into the asset class for the first time or look to top up their exposure, which I think is really quite telling and quite interesting.

I think the other point to make is anecdotally, when I look at some DMs managers, what we're seeing is actually that the majority of their exposure is to global EM companies. But actually, we would argue the opportunity is very much on the companies that are focused on domestic emerging markets. So to put that in context in terms of the opportunity, EM represents over 85% of the global population, and as I mentioned, accounts for the majority of global GDP growth. So being exposed to those domestic structural plays is really what we want to secure within the asset class. And we think there is currently a bit of an anomaly in markets where despite that huge representation of EM in terms of the population and in terms of GDP growth, EM only accounts for about 10% of the MSCI All Country World.

So that doesn't make sense to us. And in terms of domestic exposure, I think what’s also interesting, if you look at the overall emerging market asset class, it's really transformed over the last decades. So it's no longer, I think, what some investors still have in their mind in terms of being a commodity play.

I mean, countries such as Russia, which is no longer in the index, but also LatAm are only very small portions now of the asset class. It's very much more of an Asia story. And in terms of sectors, we've really moved away from commodity sectors -- so, Energy and Materials only account for about 10% of the benchmark. And it's very much more your structural growth sectors, your consumer areas and Financials and Tech that really drive the exposure of emerging market equities.

So we really think that it makes sense in order to really gain that true exposure to that structural growth opportunity, it really makes sense to be more domestically positioned in those types of companies.

Yeah, those are some excellent points certainly to consider. We've amazingly reached the end of our time, so we'll wrap it up here. Dijana, thank you, it was it was an absolute pleasure. We really appreciate you sharing your insights and perspectives with us. And, of course, appreciate your time late in the day, your time out there.

I also want to thank our listeners, of course, for taking time to join us today. We hope you can join us again on the next episode coming up in a few weeks. Thanks and take care.

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