Emerging Markets: Themes we’re watching
25 July 2025
Here our specialist Emerging Markets Equities investment partner, Northcape Capital, examines the current themes that have their attention. From the Trump presidency, to AI and China, the team share their views on where they see the main opportunities and risks for the asset class and how they are positioning the portfolio.
This information has been prepared by Northcape Capital, the underlying investment manager for the Warakirri Global Emerging Markets Fund.
Opportunities and Risks in Emerging Markets (EM)
In addition to the usual risks that we assess at the company and sovereign levels, there are a range of themes that currently have our attention with respect to portfolio positioning.
Trump Presidency
Put simply, the Trump Presidency = Policy Volatility.
This is potentially driving up the cost of capital for EM businesses for the years ahead by changing world trade and investment flows. The implication of this paradigm for EM portfolio construction is to focus on what we can control, and 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 pricing power
- Strong balance sheet
- High internal free cash flow (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 (less transparency), and weak business models.
Industry consolidation, giving 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.
Trump’s policy volatility is a factor, while higher costs of production from tariffs, globally higher debt and budget deficits and increased geopolitical risks compound the situation.
A cocktail of factors that indicate 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. This will enhance the competitive position of the leading EM companies which have strong free cashflows, a fully funded business model, and will enable them 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 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 2025 – 76% of the companies (27 out 34) are ranked number one by market share in their respective categories. This highlights how dominant this theme is in our EM strategy.
AI benefiting North Asia semi-industry for many years
The North Asian semiconductor stocks should continue to be well placed to benefit as mission critical suppliers of AI chips. TSMC (9.9% of portfolio) is our largest position and is the undisputed leader in logic chips, with only one main foundry competitor, Samsung Electronics. However, Samsung lacks scale in logic chips and is more focused on DRAM memory chips.
TSMC can also potentially continue to take market share from Intel, again due to the fact it has superior logic chip technology and scale. Indeed, it is possible over the long run that Intel may fully abandon its own chip making and outsource its manufacturing to TSMC. Likewise, SK Hynix (7.7% portfolio) and Samsung Electronics (3.5% portfolio) will continue to benefit from the AI boom for DRAM chips, although we have presently slanted the weighting towards SK Hynix over Samsung Electronics given the former has established a leadership position in relation to AI memory chips.
Supply Chain Relocation from China
COVID was a seminal event, which recognised the folly of having a supply chain overly exposed to one country, such as China. This coupled with the “economic, investment and trade divorce” between the US and China is leading to a more diverse global supply chain, that is not dependent on any one country.
In our view the key EM beneficiaries over the long-term from the redistribution of supply chains from China will be India and Mexico. We base the view on the fact that these two countries are both strategically important to the US and are more willing to place tariffs on China (similar to what the US plans to impose on the PRC). Effectively creating a “customs union” between these countries and the US. This will assist technology transfer and growth of these countries. India and Mexico remain key overweights in the Northcape EM portfolio.
Demographics
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 the exhibit below, China’s salary mass is in structural decline and will worsen with its extremely low fertility rate (approaching 1.0) and highly restrictive immigration policy. As such salary mass and household formation is falling in China, which creates an awful headwind for domestic demand.
Exhibit 1: Sovereign Risk – China V India: Demographics
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.
Conversely, countries with favourable population pyramids, and healthy fertility rates will have greater potential for 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 omni-present in EM. The select few that are best placed in our view are India, Indonesia and Mexico, whilst having other important and favourable characteristics. These countries are key overweights in the portfolio, whilst China is a deep underweight.
Taiwan is strategically important to the US
Given all the leading-edge AI related semiconductor chips are made in Taiwan by TSMC, the US, even under Trump, will still provide a strong umbrella of protection for the island state, in our view. Contrary to some opinions, we do not believe Trump will “throw Taiwan under the bus” in order to reach a deal with China’s President Xi.
The US cannot afford China getting around the Chips Act by taking over Taiwan and commandeering TSMC’s leading-edge foundries, then ultimately using the technology in military applications against the US and its allies. Moreover, pending elections in Taiwan will likely see the US leaning government of Taiwan regain control of the state legislative branch, thus enabling the country to increase its defence spending, and better align with US requests.
In short, Democrats or Republicans are both committed to Taiwan, thus limiting China’s access to leading edge chips. This is a factor in our current low weighting towards China, in addition to others mentioned.
For more information, please contact us on 1300 927 254 or visit Warakirri Global Emerging Markets Fund.
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.
