Why the way most people invest in emerging markets Is broken (and what it means for you)

Emerging markets represent one of the biggest opportunities in global investing—but most investors are approaching them all wrong. Here's why this matters, even if you're not a professional investor.

The Problem: Following the Recipe Everyone Else Is Using

In emerging market investments, institutional investors often reference widely used benchmarks, such as the JP Morgan EMBI Global Index. These indices are developed by specialised providers and are broadly used across the industry.

But here's the issue: these benchmarks were never designed to help you achieve your investment goals. They were designed to be trackable and measurable. Those are very different objectives.

What This Actually Means for Your Returns

Let's break down the real-world impact:

If you are not getting the diversification you are seeking – When 60%¹ of your "diversified" emerging market allocation goes to just 10 countries, you're not spreading risk—you're concentrating it. If these big, popular markets all move in the same direction (which they often do), your diversification benefit evaporates.

If you are not fully capturing yield opportunities – These popular indices are stuffed with investment-grade bonds that offer tiny spreads over US Treasuries—often just 50 to 150 basis points². If you wanted that level of return, you could have stayed in developed markets and saved yourself the trouble.

If you are taking on exposures that are not immediately apparent – By defaulting to 100%³ US dollar-denominated bonds, you're betting big on the dollar's continued strength. From 2004 to 2014, that bet would have cost you dearly as local currency bonds massively outperformed. The "safe" default turned out to be a risky concentrated position.

The Opportunity Most Investors Are Missing

Here's what makes this particularly frustrating: the tools to fix these problems already exist. They're just being systematically ignored.

Frontier markets offer genuine diversification and often hold up better during crises than supposedly "safer" emerging markets. The International Monetary Fund has dramatically expanded its safety net for these countries, reducing default risk. Yet most portfolios exclude them entirely.

Local currency bonds provide a way to avoid making a single massive bet on the dollar. They let you access different economic cycles and interest rate environments. But most benchmarks stick to 100% dollar exposure.

Emerging market corporate bonds represent a $14 trillion market—nearly as big as all developed market sovereign debt—with better fundamentals than many US companies. They offer shorter duration, better credit ratings, and lower leverage. Yet they're routinely excluded from emerging market allocations.

Why This Matters Now More Than Ever

The global economy is shifting. The dollar won't strengthen forever. Frontier markets are professionalizing. Emerging market companies are maturing into world-class competitors.

If you're invested in emerging markets through traditional benchmarks, you're positioned for the world of 2004, not now. You're owning yesterday's winners while ignoring tomorrow's opportunities.

The Real Risk Isn't Where You Think It Is

Here's the uncomfortable truth: the biggest risk in emerging market investing might not be investing in the "wrong" countries or taking too much risk. It might be following everyone else into the same obvious places without questioning whether the conventional approach makes sense.

When everyone crowds into the same trades, those trades stop working. Mexico and Brazil crashed during the 2024 carry trade crisis partly because too many investors were making the same bet.

When everyone ignores the same opportunities, those opportunities persist. Emerging market corporates with 0.9x leverage⁴ and BBB- ratings trade at yields that reflect BB+ risk, simply because they're labeled "emerging market."

When everyone makes the same hidden currency bet, that bet becomes dangerous. A dollar regime shift could upend returns for millions of investors who thought they were being conservative.

What You Can Do About It

This doesn't mean you should abandon emerging market investing. It means you should think more carefully about how you access it.

Ask yourself:

• Am I actually getting diversification, or am I just owning a few popular names?
• Am I being compensated for the risks I'm taking, or am I accepting emerging market volatility for developed market yields?
• What hidden bets am I making, and do I actually want to make them?
• What opportunities am I systematically excluding, and why?

The smartest investors don't follow benchmarks blindly. They challenge assumptions, look for opportunities others are ignoring, and think critically about whether conventional wisdom actually serves their goals.

In emerging markets especially, questioning what "everyone knows" might be the most valuable thing you can do.

Adapted from: Hardingham, N., & Ouwendijk, S. (2024). Beyond the benchmark: Redesigning emerging market debt allocations. Franklin Templeton.

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