Emerging Markets Equities – Opportunities and Risks

29 July 2026

In this paper our specialist emerging markets equities partner, Northcape Capital, shares the range of opportunities and risks currently holding their attention with respect to portfolio positioning. Some of the themes discussed are new while others are consistent with the team’s previous reviews as they are long-term and structural in nature.

This information has been prepared by Northcape Capital, the underlying investment manager for the Warakirri Global Emerging Markets Fund.

What’s driving returns — and what’s driving risk in EM equities

There are a range of opportunities and risks that currently hold our attention with respect to portfolio positioning. Some of these are new and others are carry-overs from our 2024 and 2025 reviews as they are long-term and structural in nature.

Trump Presidency – Creating Higher Cost of Capital

Put simply, the Trump Presidency = Global Policy Volatility.

In 2025, the defining development was the imposition of U.S. tariffs on virtually every country in the world, coupled with increased pressure on its allies, particularly NATO members, to take greater responsibility for funding their own defense. While in 2026 it has been the US decision (with Israel) to start a war with Iran. These policy shocks have clearly driven up the cost of capital for businesses by further changing world trade and investment flows, increasing global defense spending (creating larger budget deficits) and raising inflation expectations. This higher cost of capital has been manifested in rising government bond yields with the key benchmark for EM (the US 10-year government bond) lifting from a low of 3.6% in 2024 to 4.5% in June 2026.

The implication of this US policy volatility (and higher cost of capital) for EM portfolio construction is to focus on what we can control, and to reiterate this means owning the most robust EM companies with the following attributes:

• Transparency in asset valuation
• Strong competitive advantages, with high quality and sustainable business model
• Market heft giving greater pricing power in the face of higher inflation risks
• Strong balance sheet
• High internal FCF generation (not reliant on debt or equity to fund growth)
• Structural growth of product or services, with adjacent market opportunities
• Good management, with tight governance oversight
• Limit portfolio exposure to unfunded EM start-ups, private equity (limited transparency), weak business models

Industry consolidation – Driving Increased Pricing Power and Higher ROEs for Industry Leaders

In our view the days of zero interest rates (free money) are behind us in the medium-term. This period (2011-2022) will increasingly be seen as an “abnormal” and not an interest rate regime that capital markets will revert back to. Global policy volatility is a factor, while higher costs of production from tariffs, disruption costs from the deployment of AI, higher debt and budget deficits and increased geopolitical risks are compounding the situation. This cocktail of factors indicates to us that interest rates will stay higher for longer and will put a limit (or much higher cost) on the supply of capital to start-ups and/or businesses with negative free cashflows.

This is especially the case in EM where interest rates are generally much higher than in the US, Europe, and Japan. Indeed, the average 10-year bond in EM (major countries) is currently 6.1%, almost +300bps above the DM average. Average bank lending rates at 10-12% for EM are typically +400-600bps higher than DM rates. This higher lending rate enhances the competitive position of the leading EM companies which have strong free cashflows (i.e. not reliant on expensive bank lending to fund their businesses). This enables the market leaders to grow their market share by reinvesting in their business at a higher rate than their poorly funded competitors. This should drive industry consolidation, improving pricing power (delivering a better hedge against inflation) for the market leaders. Returns on capital for leading EM companies, to which the portfolio is strongly biased, should also increase and therefore support higher valuations. In fact, as we look at the portfolio at 30 June 2026, 80% of the companies (25 out 34) are ranked number one by market share in their respective categories. This highlights how dominant this theme is in our EM strategy.

Global Capex – Strategic Increase to Benefit EM

Notwithstanding the prospects of a higher cost of capital over the long-term, one of the other key implications of the increased geopolitical risks is the drive for economic and national security self-sufficiency. This, in our view, will have a positive impact on global growth, which could be potentially higher than currently expected for the next decade.

Specifically, the accumulated impact of COVID, US tariffs, wars in Eastern Europe and Middle East, is a structural shift in industrial and energy supply chains away from China, Russia and Middle East and increasingly centered around “home or national” markets.

To achieve the global “relocation” of industrial and energy generation capacity to home markets will require a huge amount of public and private capital expenditure (capex) over many years. Additionally, countries are increasing their defense spending to improve their national security, which is due to recent wars, but also due to policy shifts requiring countries to become less reliant on US military support.

On AI, many countries are increasingly looking to develop their own AI capabilities, so that they are not beholden to US and China suppliers such as Anthropic, Open AI, Google and DeepSeek. This is deemed politically important from nation building and data security standpoints, but also in terms of creating homegrown platforms to develop their own value-added industries from AI.

In summary, the relocation of industrial and energy supply chains and creation of more self-reliant national military and AI capacities all speaks to significantly increased capex at a global level.

The most recent example of a new “strategic” national development capex plan was announced on 24 June by Japan’s PM Sanae Takaishi. The Japan plan has a budgeted spend of US$2.3trillion over the next 14 years focused on investments in AI, industrial robots and military defense to “future proof” its economy. Japan’s current GDP is US$4.4 trillion, so this spend represents over 50% of the current base, a massive initiative! This kind of expenditure could be replicated by the EU, US and many other developed countries at similar levels as % GDP should they want to keep pace with Japan, which is aiming to keep up with China.

In this new world paradigm of nation building, it seems developed country public and economic policy is becoming more like China’s – that is focused on national interest goals first. Given the scale of this expenditure, we can see why this is so positive for global growth.

What are the implications for EM? We can see three positives for EM.

• EM is the main supplier of commodities to the global economy, and this “national interest” expenditure is very resource intensive, especially for industrial metals (such as copper, aluminum, steel, zinc, nickel).
• It will also have a positive impact on the demand for energy, especially renewables (solar and associated battery technologies) which reduce reliance on the Middle East and produce less carbon emissions – EM is also the main supplier of renewable technologies to the global economy.

This potentially means EM exports, terms of trade and overall GDP growth should be key beneficiaries of the global drive for economic, energy, AI and military self-sufficiency. Taken together this should assist the relative valuation of EM currencies versus the US dollar – a tailwind for the EM equity asset class.

AI – Signs of Irrational Exuberance in South Korea and Taiwan

Irrespective of the eventual economics of the AI data centre build out, there are signs of irrationality in the equity markets of South Korea and Taiwan – which now have a combined weight of around 50% of the MSCI EM index. Exchange-traded funds (ETFs) have become the preferred investment vehicle for retail investors seeking exposure to the Korea/Taiwan AI investment theme, but these instruments have departed from their original purpose. ETFs were originally designed to provide exposure to an underlying asset that was difficult for retail investors to access directly, for example a commodity or a stock index. However, in the most recent AI-driven stock market boom they have frequently become a way for retail investors to simply add leverage to their stock bets via the rise of single-stock ETFs. Half of share trading on South Korea’s stock exchange is now driven by ETF buying and selling alone. And the largest ETF in Hong Kong is the CSOP SK hynix 2x Leverage, whose assets surged to more than US$17 billion, making it even larger than the Hang Seng Index ETF. The HK SK hynix ETF is designed to use leverage to amplify moves in SK hynix’s shares, such that a 5% move in the ordinary shares would be a 10% move in the ETF. There are two main concerns:

• There is evidence that retail investors are borrowing money to buy leveraged ETFs, creating multiple layers of borrowing;
• Rather than replicating movements of underlying shares, the sheer size of single stock ETFs means that ETF flows are increasing, driving share price movements in ordinary shares – the exact opposite of the way ETFs are supposed to work.

Every major stock market bust in history featured the combination of high retail investor participation and significant leverage, so it is no wonder that the South Korea’s top financial regulator recently expressed regret at not blocking the launch of leveraged single stock ETFs. South Korea’s Financial Supervisory Service (FSS) estimates that more than 90% of owners of single stock ETFs are retail investors. In our view, there will be an inevitable fall-out from this leveraged ETF activity, which may manifest a potential sharp correction in the underlying semiconductor equities; especially vulnerable is SK hynix, which now accounts for about 8% of the EM index. This risk is a key factor in explaining why we are currently deeply underweighting the South Korean semiconductor sector.

That being said our current portfolio still has about 20% of its exposure dedicated to Taiwan and South Korea semiconductor stocks (versus index weighting of about 40%). Our investment is based on the possibility that the demand for compute memory could be stronger for longer, which sees the more elevated levels of profitability across the semiconductor industry being maintained for a year or two more, before there is inevitable price correction. Our exposure is largely made up of TSMC followed by Samsung Electronics, which in our view are less cyclical and have much less “hot” retail shareholders on their registers than SK hynix.

Ex-AI Potential Value Creation in our EM portfolio

The rapid rise in liquidity rushing into AI-linked semiconductor and related AI data center stocks over the past year has in many cases been funded by indiscriminate selling of other stocks – some are on our EM Approval List and in our existing portfolio. However, this selling of so-called ‘non-AI’ stocks has created some exceptional bargains, which we have been adding to over the past six months. (This has been funded by trimming our exposure to the very strongly performed AI semiconductor stocks; TSMC, Samsung Electronics and effective selling out of SK hynix).

Crucially, many of these downtrodden stocks are potentially significant beneficiaries of AI by way of improved productivity and potential revenues gains. All these companies are the leaders in their respective industries, and as such, have the scale and heft to deploy AI technologies on a deeper, more widespread basis than their peers, which has the additional potential of improving their long-term competitive position, market share, growth and returns on capital. Essentially, this enhances the company’s ability to create increased levels of shareholder value.

Looking at the current valuations of these stocks, many are trading at five, ten, and even twenty-year low multiples, “nadir” valuations, which has really caught our attention. Indeed, the upside from AI in many cases is not being priced into these stocks at all, representing a ‘free option’. This clearly speaks to the intrinsic value in our EM portfolio at present and thus provides an attractive entry point in our view for new and existing investors.

Demographics – Impact on Salary Mass

Finally, our “top down” view remains unchanged on the issue of demographics being a long-term tailwind for the EM asset class. Exposure of the portfolio continues to be heavily weighted towards countries where salary mass (i.e. the number of people employed multiplied by average weekly earnings) and household formation are both growing.

As can be seen in Exhibit 1, China’s salary mass is in structural decline and will worsen with its extremely low fertility rate (0.9 births per woman) and highly restrictive immigration policy. As such salary mass and household formation is falling in China, which creates an awful headwind for domestic demand. Long-term sales growth for domestic China companies is set to fall, and materially in our view. This will have a profound negative impact on the valuation of China’s companies, as the terminal value is substantially depleted by a much lower sales level.

Exhibit 1: China v India Demographics and Salary Mass

Source: UN Data

Conversely, countries with favourable population pyramids, healthy fertility rates will potentially have very strong growth in salary mass and household formation, thus driving robust consumption growth for decades ahead. This is a massive long-term “tailwind” for sales growth of the companies addressing these countries. Essentially the company’s sales base in the terminal year (10-20 years out), is set to be substantially higher, thus supporting a vastly higher stock valuation over time. This is the so called “demographic dividend”. However, this dividend is not omnipresent in EM. The select few that are best placed in our view are India, Indonesia, South Africa and Mexico, whilst having other important and favourable characteristics. These countries are key overweights in the Northcape EM portfolio, whilst China remains a deep underweight.

For more information, please contact us on 1300 927 254 or visit Warakirri Global Emerging Markets Fund.

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The information in this document is published by Warakirri Asset Management Limited ABN 33 057 529 370 (Warakirri) AFSL 246782 and issued by Northcape Capital ABN 53 106 390 247 AFSL 281767 (Northcape) representing the Northcape’s view on a number of economic and market topics as at the date of this report. Any economic and market forecasts presented herein is for informational purposes as at the date of this report. There can be no assurance the forecast can be achieved. Furthermore, the information in this publication should only be used as general information and should not be taken as personal financial, economic, legal, accounting, or tax advice or recommendation as it does not take into account an individual’s objectives, personal financial situation or needs. You should form your own opinion on the information, and whether the information is suitable for your (or your clients) individual needs and aims as an investor. While the information in this publication has been prepared with all reasonable care, Warakirri and Northcape do not accept any responsibility or liability for any errors, omissions or misstatements however caused.