2026 will be a year of net inflows into emerging market (EM) asset classes got off to a strong start. Except for large outflows from China driven mainly by a Chinese-specific idiosyncratic story, inflows have risen through the first two months of 2026.
Retail investors have allocated more funds towards both broad EM ETFs – without classifying countries – and country – and regional-specific funds. Besides China, all regions have seen a significant pick-up in inflows in January and February. While more difficult to track, non-ETF flows have likely behaved the same way.
Most EM equities have outperformed the MSCI World
Driven by inflows and a favourable backdrop, the MSCI EM index has outperformed all of its peers with a 13% rise year to date. While MSCI China has only gained about 2%, the performance has been driven by a surge in Korea and Taiwan – 44% and 22% respectively. The two markets now accounted for 37% of the EM index at the end of January. But the weighting of the index may have masked the good performance across other EMs. Latin American equities have risen across the board with gains ranging from 15% (Mexico) to 21% (Brazil) and 31-32% (Peru and Colombia). EMEA equities have also done well with Turkey and South Africa gaining 25% and 13% respectively. Stronger local currencies have been part of the story in most cases.
EM debt has performed well
EM debt has also performed well, led by local currency bonds with total returns reaching 3%. Sovereign hard currency debt has gained 2% and corporate hard currency debt has risen 1.4%. EM currency appreciation is behind the robust performance of local currency bonds. A weaker US dollar, which followed geopolitical tensions over Greenland in mid- January was the main reason. In hard currency debt, lower US rates, credit rating upgrades – mainly in sovereigns – and solid corporate balance sheets have translated into stable gains.
US dollar likely to remain weak
The question is whether this good performance will continue. One key driver to EM performance and inflows is the US dollar. The US dollar is likely to remain weak this year. Still, the US dollar could move higher this year if the US administration becomes less unpredictable or if the midterms lead to a situation where the executive branch becomes more constrained in its policymaking. Evidence so far has not been supportive of a more moderate US administration. While the decision by the Supreme Court to strike down the President’s use of the International Emergency Economic Powers Act (IEEPA) to levy tariffs on other countries shows that checks and balances still work in the US, the administration’s attempt to use other channels to collect tariffs has once again increased policy uncertainty.
AI scare trade has not affected demand for chips
Other supportive factors for EM performance are the AI investment cycle and the massive resources needed to deploy AI. In equities, the market has rotated from AI investment excitement to the ‘AI scare trade’ where those who are expected to lose from the advances in AI – such as software companies – are punished by the market. Korea and Taiwan, the two markets that have clearly benefited from the AI investment cycle, rely on their ability to produce chips which are required for computing power and are important parts of data centres. While the number of data centre cancellations has risen, demand for chips remains strong.
Global investment cycle to support metals demand
Resource-rich EMs have benefited from commodity price rises. High gold, silver and copper prices have supported markets such as Chile, Peru and South Africa, as well as frontier markets such as Uzbekistan. This trend is expected to continue, with rising fixed capital investment in parts of the world supporting it. While fixed asset investment in China was in a slump late last year, it should improve this year. In the euro area, there is already some evidence that the German economy is turning the corner with its large spending on defence and infrastructure.
EM valuations remain relatively attractive
In equities, EM valuations have increased from their lows last year but have remained relatively low compared to world equities. The MSCI EM index’s 12m forward P/E is currently at 17.7x, higher than its 10-year average of 13x, but the multiple relative to the MSCI World is still slightly lower than the 10-year average value. In hard currency debt, credit spreads have fallen further year to date from a tight level, making the asset class vulnerable to risk-off episodes. Carry remains high, however, helping to offset moderate spread increases. For local currency bonds, policy rate cuts in central and eastern Europe and Brazil should support local currency bonds, provided that the fiscal situation does not deteriorate. Fiscal improvement, which has been notable in Romania, South Africa and Turkey will likely be rewarded further. High rates in Latin America should also support their respective currencies.
By Mali Chivakul, emerging markets economist at J. Safra Sarasin Sustainable Asset Management
