Positive for emerging markets

Source: Bloomberg, as at April 10, 2026

Learn fast and adjust

In last month’s commentary, we discussed our approach to forecasting and portfolio management in times of market stress with reference to the OODA (Observe, Orient, Decide, Act) Loop below.

To quickly recap:

Through periods of high uncertainty and violent market moves like what we have currently, we lean heavily into this OODA Loop. This involves a constant testing and re-testing of our macro views and investment hypotheses, and tweaking of the portfolio as conditions change.

We thought this thematic would be worth unpacking further, as these markets provide a great illustration of how a robust process can help navigate periods of high volatility and uncertainty.

Sweating the capital

This approach helps us to remain disciplined, learn fast as new information arrives and make small, frequent adjustments to ensure there is tight alignment between evolving beliefs and portfolio risk.

We call this “sweating the capital,” with the aim being to:

1. Limit the size and persistence of errors without dulling upside capture; and
2. Maximise risk-adjusted returns over the long run.

In a volatile quarter, the portfolio outperformed thanks to a balance of investments in focused, volatile, risk-on names across niches in the AI supply chain in Taiwan and South Korea, alongside more defensive holdings including oil producers, Asian financials and Brazilian water utilities. The former outperformed through January and February, while the latter helped us hold on to relative gains through a risk-off period in March.

Achieving the right balance of risk across the portfolio is the output a rigorous process based on a set of long held beliefs (the impact of liquidity in driving prices, importance of macro sensitivity in EM and peer review to guard against behavioural error), all of which is all geared to matching the capital in the portfolio with the conviction of the team.

It sounds very simple, but it is a demanding process, requiring tight collaboration across a team of experienced and opinionated investors, as well as the discipline and energy to continually update beliefs, capital and conviction as conditions change.

That discipline is especially important for navigating times of high uncertainty and market volatility.

Process under pressure

The testing and re-testing of investment beliefs in our process takes place formally through weekly investment policy meetings, along with monthly country and stock meetings. This structure helps us orient ourselves and debate how best to move ahead while documenting everything as we go.

Gulf War III is a powerful example of how volatile markets expose habits and test investment beliefs. These periods throw so much information at investors that it can be paralysing to a team without well-established and repeatable decision-making routines.

For us, disciplined preparation, structured collaboration and strong behavioural standards are key tools for us to maintain emotional control and remain focused on execution.

Calm, clear and deliberate decision making

One example of how structure and routine help aid our decision making is through the team stock meeting. Here we discuss any portfolio companies whose stock has moved up or down by a certain threshold amount in relative terms. In either case, this involves the team re-testing the investment hypothesis for a given name to assess whether it remains intact.

We do not rely on static forecasts from the original stock research notes on companies to guide us through an uncertain period like this. Instead, the review trigger – a fairly modest relative stock move – forces us to re-underwrite our forecasts and adjust conviction accordingly.

The result is that we can quickly identify winning ideas and scale them up, as the meeting and team discussion help us cut through the market noise and identify improving fundamentals earlier, even when uncertainty is high. Equally, it allows us to cut losers faster when new information invalidates an investment thesis, helping to avoid thesis drift and subsequent drawdowns.

This process has been crucial for operating in whipsawing markets like this.

It has provided opportunities to tilt the portfolio towards areas where attractive long-term prospects remain intact, and are also more insulated from the energy shock. Below are two examples.

AI memory bottleneck

“High bandwidth memory is the single biggest bottleneck to scaling AI systems today.”
— Dylan Patel (SemiAnalysis), as discussed in an interview on the Dwarkesh podcast, March 2026

As we wrote back in early 2024, the difficulties in scaling up high bandwidth memory supply amid explosive demand to support AI GPU clusters is driving a cycle of unusually strong margins, cash generation and earnings visibility for DRAM giants SK Hynix and Samsung Electronics.

Historically significant – this cashflow is off the scale

Source: KB Securities, March 2026

However, our level of exposure is tempered by caution over risks of US hyperscalers pulling back AI investment, the emergence of circular financing arrangements and increasing reliance on debt.

Necessity is the mother of invention – cheap energy is China’s answer to US compute edge

Source: Bernstein, March 2026

China playing catch-up through more (and less efficient) chips and bigger data centres

Source: Bernstein, March 2026

Last year, China added an enormous 500 GW of power capacity to its grid, more than the rest of the world combined. Much of this comes from rapid growth of solar energy, by some measures now cheaper than coal power in China.

The battery and power management technology supplied by portfolio company CATL is crucial to this revolution.

In-depth macro analysis has always been a cornerstone of this process, based on an understanding that emerging markets are highly sensitive to macro shocks which can overwhelm ostensibly solid company fundamentals. The outbreak of conflict following US and Israeli strikes to take out the Iranian regime is one such event, and has sparked violent moves in markets. Our macroeconomic analysis and risk controls are crucial in helping to navigate a volatile environment.

The approach to macroeconomic analysis here is disciplined and incremental, and does not involve the type of Hail Mary calls (i.e., speculating on President Trump’s war aims) that get market pundits invitations onto Bloomberg and CNBC. Our approach to forming a top-down view of our markets is to mark the direction of travel, whether it be our monetary indicators or more qualitative factors such as politics and institutional quality. We marshal all of these data points into one number which rates the level of conviction for a country with 1 being the highest level of conviction corresponding with a maximum overweight (key caveat: provided we can find the right stocks that fit our process), and 5 being lowest (meaning no exposure at all). As the data changes, we will tweak that level of conviction, which should be tightly aligned with adjustments made in the portfolio.

This work is designed to help us understand how the investment environment is changing through cycles, structural change and theme-driven liquidity. Through this context, we can get a sense of what types of businesses are likely to be rewarded in a given environment and adjust the portfolio accordingly.

Test and re-test

We are big subscribers to the insights of psychologist and writer, Phillip Tetlock, who is an expert on forecasting. His studies found that the best long-term forecasters are those who are able to make probabilistic estimates, calibrate, learn and update beliefs frequently. They make many small corrections to their analysis as fresh data arrives, which leads to better long-run accuracy than rigid “set and forget” predictions. This is the forecasting approach we adopt in both our macro and company analysis, illustrated in our process diagram below.

Through periods of high uncertainty and violent market moves like what we have currently, we lean heavily into this OODA (Observe, Orient, Decide, Act) Loop. This involves a constant testing and re-testing of our macro views and investment hypotheses, and tweaking of the portfolio as conditions change.

Example: lifting oil exposure

Moving from being zero weight in oil companies at the start of 2026 to equal weight (and with more beta to oil than the index) by the end of February is one example of how iterative tweaks in our macro analysis left the portfolio in a better position to weather the events of early March.

Towards the end of last year, one of the most debated topics of discussion in the team was our heavy underweight to the energy sector and, in particular, oil. Our only energy holding at the end of 2025 was uranium miner CGN.

While we remain structurally cautious about oil’s long-term investment prospects, from a portfolio risk perspective we became concerned that having no oil exposure had turned into a crowded consensus trade – especially as weak prices began to squeeze US shale production. This alongside news of a US naval build up in the Persian Gulf, Arabian Sea and Eastern Mediterranean early in the year suggested the portfolio was exposed to risk of a geopolitical shock in the region. Through January and February, we gradually lifted our oil exposure from zero to an equal weight of over 3.5%.

While our macro and risk analysis helped to identify a potential vulnerability, we could not know that conflict was about to break out in early March and drive such a dramatic hike in the price of oil. It was not a case of just adding oil beta to the portfolio. We added Argentinian shale oil producer Vista Energy and Petrochina based on their healthy returns on invested capital sustainable even through weak pricing environments, underpinned by growing production profiles, capital discipline and low lifting costs.

Vista Energy: Production growth and falling lifting costs driving earnings growth



Source: Vista Energy Investor Relations 2026

The lift to oil exposure was timely, helping to preserve relative gains made this year despite sharp drawdowns in other winning positions that had been hit by broad risk-off sentiment.

Where to from here?

We rated the global monetary backdrop as modestly supportive coming into this shock, largely reflecting favourable trends in EM. However, we have been expecting the global stockbuilding cycle to turn down during 2026, giving us a bias to increase defensive positioning at the margin, especially on any signs of monetary weakness.

The energy price spike, unless swiftly reversed, will push up inflation and squeeze real money growth. It is leading to a revision of expectations for central bank policies, which may dampen nominal money growth. Nominal money trends are also at risk from recent tightening in US private credit conditions, which the current shock may exacerbate.

We are cautious and do not expect the negative effects of this shock will be swift to reverse, so our inclination is to add to defensive positioning on any rally, rather than to view current market weakness as a buying opportunity.

The rapid repricing of global gaming equities year to date reflects a sharp narrative pivot in the market, hitting the stocks of portfolios holding Tencent, as well as other leading players such as Nintendo and Roblox. Only months ago, consensus held that AI would be an operational tailwind for game developers through cost reduction and faster content generation.

AI enhancing content production and experience

Source: Tencent Investor Relations 2026

Following new AI model releases such as Anthropic’s Claude Code and Google’s Project Genie, the prevailing fear is that AI will disrupt traditional game development entirely.

The question for investors is whether Tencent, as the world’s largest gaming company by revenue, is positioned to benefit from or be impaired by this shift.

AI as a development tool

Tencent’s core strength is scale – both financial scale and model training scale. In discussions with management late last year, they emphasised that AI is already deeply embedded in their workflow: procedural content generation, NPC behavioural modelling, art and animation tooling and faster iteration cycles. These capabilities are not theoretical; Tencent purchases more AI compute and silicon than nearly any other company in Asia, outside hyperscalers.

Small studios will indeed be empowered by AI, lowering entry barriers and enabling “one hit wonder” creators, much like YouTube transformed video production.

However, distribution, marketing and IP longevity remain durable moats. Tencent excels in all three. Owning evergreen franchises – over 80% of its portfolio – means that even if development costs fall, the value of recognised IP rises.

Source: Tencent Investor Relations 2026

AI makes content easier to create, but not easier to distribute at scale, monetise efficiently or ensure regulatory compliance – areas where Tencent’s ecosystem advantage is overwhelming.

Golden age of movie studios gives way to more atomised content creators – parallels?

Consider the shift from studio dominance in Hollywood to a more atomised creator economy. AI could indeed enable a long tail of nimble game creators, just as digital tools transformed music and film production. If so, Tencent’s role may shift toward that of a global distributor and platform – akin to Netflix in video or Spotify in music.

But unlike movies, gaming economics rely heavily on ongoing monetisation: loot boxes, in-game economies, battle passes, skins and continuous seasonal content. Even if AI reduces production costs, developers with large user bases can simply retain the value by expanding monetisable content. Consumers rarely pay less – they typically pay more in more immersive and interactive environments. Tencent’s superior ability to drive retention and average revenue per user works in its favour.

Fear premium

Tencent today trades at ~16x PE with mid-teens EPS growth, and minimal risk to near-term earnings. This is historically inexpensive for a high-quality global IP and distribution engine. The derating reflects uncertainty over future industry economics – not current fundamentals.

The key debate is not whether Tencent gets disrupted this year (unlikely), but whether AI compresses long duration returns on capital for AAA studios globally.

Markets are trying to reprice the terminal value of moats like content creation and distribution.

Our view: Tencent is better positioned than most

AI will shift value around the gaming ecosystem. Some of that may move to consumers, some to new AI native studios and some to distributors. But scale matters. IP matters. Distribution matters. And Tencent is uniquely advantaged in all three.

The company may face multiple compression as investors debate the long-term competitive dynamics, but fundamentally, Tencent is more likely to be a beneficiary of AI than a casualty. The path will be volatile, but the structural advantages remain intact.

Trump’s trade doctrine: Opening the door to higher-return industrial champions

Last month, I spoke with Benefits and Pensions Monitor about the short-term noise generated by Trump tariff headlines. We explored whether investors should be looking through the noise based on the TACO (Trump Always Chickens Out) view that the US president will retreat in the face of market revolt.

My argument was that, while amusing, TACO risks obscuring the unmistakable direction of travel. US trade policy signals a shift to a multipolar world, defined by a US centric economic sphere and a China centric one, each with competing supply chains, industrial priorities and strategic alliances. Tariffs are signals of tectonic shifts in global trade.

Our view is that these shifts bring risks, but will also be a durable source of opportunity for EM investors.

When China is taken out of your supply chain, everyone makes money

Traditionally, sectors like shipbuilding, industrial machinery, energy logistics and specialty manufacturing have been deeply cyclical with limited pricing power. They lived and died by freight rates, commodity cycles and economic growth. But the combination of US reindustrialisation, reshoring and decoupling from China is transforming these industries.

Historically commoditised, price‑taking businesses are now at the heart of national security and industrial policy. Reindustrialisation and rebuilding supply chains have the potential to drive visibility, margins and returns on capital that would have been unthinkable a few years ago.

For example, the order books of Korean shipbuilders are increasingly less shaped by commercial shipping cycles, and increasingly by long‑cycle defence, LNG infrastructure and government‑aligned industrial programmes across the United States and its allies.

Major opportunities ahead for Korean shipbuilders in LNGC and naval vessels

Source: CLSA, Clarksons

US-China decoupling has effectively removed Chinese yards from security‑sensitive projects, structurally elevating demand for non‑Chinese capacity.

For countries aligned with US industrial and security priorities – Korea, Japan, India, parts of ASEAN – select industries have the potential to enjoy rerating as increasingly strategic rather than cyclical businesses.

This extends far beyond shipbuilding. We are seeing it in components for AI data centres, grid and power equipment, strategic metals, defence, electronics, energy infrastructure and advanced manufacturing.

These sectors are beginning to enjoy the boost of multi‑year, policy‑backed spending.

Many EM countries offer the scale, labour force depth and geopolitical neutrality that global supply chains now require. As the world bifurcates, EM manufacturers, suppliers and logistics operators are becoming essential nodes in both the US and China spheres. This creates a long pipeline of opportunities in markets that historically suffered from volatility and low returns.

In short, Trump’s trade doctrine accelerates a global realignment that raises the return potential of industries previously stuck in low‑margin cycles.

Venezuela and the arrival of the “Donroe Doctrine”

Trump gunboat diplomacy in the Caribbean has culminated in the seizure of Venezuelan leader Nicolás Maduro on January 3, 2026. The move has been widely touted as part of a revived Monroe-style foreign policy doctrine in the United States which aims to assert regional hegemony by shaping political trajectories through the region.

More muscular regional foreign policy from the United States under President Trump reinforces a rightward political shift across the region. Economic instability, corruption and crime have been the fuel for voters to favour conservative and far right candidates in elections across Argentina, Bolivia, Chile, El Salvador and Honduras. The United States has signalled in recent months that it is prepared to strengthen the hand of conservative political actors aligned with its strategic aims (e.g., the US Treasury’s $20 billion currency swap line with Argentina’s central bank).

Maduro’s capture sends a clear message – particularly to Latin America’s left-wing politicians – with respect to the lengths to which Washington will go to protect its economic, geopolitical, security and ideological interests in the region.

The rise of economic conservatism with a backstop from the United States has already stoked optimism in regional equity markets on hopes for pro-business reforms, deregulation and fiscal discipline. While LatAm’s equities markets were buoyant in 2025, we think there is potential for positive momentum to pick up as the continent embraces fiscal conservatism.

As we have written previously, Brazil remains the largest market that can move the dial for EM equities should voters go with an economic moderate over incumbent President Lula in this year’s presidential elections. Below, our LatAm portfolio manager Luis Alves de Lima provides an update on prospects for the market.

Will Brazil be the next domino to fall in LatAm’s shift to the political right?

With the FIFA World Cup and presidential elections looming, 2026 shapes up as a big year for Brazil. While my Brazilian compatriots and I remain as passionate as ever about football, I think that politics is poised to steal the spotlight from the pitch.

In my view, the “Hexa” (Brazil’s longed-for sixth World Cup win) remains a distant national dream reflected in rather long odds among the bookmakers. The better bet is for a market-friendly political shift and subsequent bull market in Brazilian stocks.

However, it would be foolhardy to call time on a political operator as wily as Lula da Silva. We have written in previous commentaries about the potential for a conservative moderate such as Sao Paolo governor Tarcísio de Freitas to win the presidency. He remains the markets’ preferred candidate, being a technical, pro-market leader capable of bridging the gap between the Bolsonarista base and the moderate right. However, recent data from the December 2025 Quaest polls suggests a more complex reality.

Senator Flávio Bolsonaro, the son of the former president Jair Bolsonaro (now in prison for a botched coup attempt), has reached parity with Tarcísio in presidential vote runoff simulations, both trailing President Lula in a 46% to 36% split. This shift has emboldened the Bolsonaro family to prioritize their own political legacy, seeing an opportunity for Flavio to inherit the mantle of right-wing standard-bearer rather than coalesce around a moderate more likely to garner wider public support.

Critically, and much to the consternation of investors, Governor Tarcísio has said he will not run for president if Flávio Bolsonaro maintains his candidacy. Driven by a deeply held sense of loyalty and a desire to avoid fracturing the conservative base, Tarcísio has essentially signalled that he will remain in São Paulo if the “heir apparent” proceeds.

This is the worst-case scenario and would leave voters with a choice between two populists who feed on political polarisation. President Lula would welcome the prospect of Flávio’s candidacy, where he can home his narrative for the candidacy in on the threat to institutions of a Bolsonaro presidency.

Political sands will continue to shift as 2026 unfolds

These recent developments are no doubt a knock to the short-term bull case to Brazilian equities. However, getting overly fixated on this “nightmare scenario” would be a mistake. The field is deeper than current headlines suggest.

Even if Flávio remains the standard-bearer for now, there is potential for alternative candidates to grow in the polls should the electorate favour administrative results over populist chaos.

Figures like Governor Ratinho Júnior (Paraná) and Governor Romeu Zema (Minas Gerais) have built formidable reputations for fiscal discipline and efficiency.

The emergence of Renan Santos and the MBL’s “Missão” party represent a youth-driven movement prioritising fiscal conservatism, anti-corruption and law and order, which could disrupt the duopoly between Lula’s PT party and the Bolsonarismo right as we approach the March 2026 deadline for candidate clarity.

Market implications

There are two primary reasons for constructive optimism in thinking about the outlook for Brazilian stocks:

First, Brazil is not an island; it is part of a decisive continental swing to the right. In December, we saw José Antonio Kast’s victory in Chile, this on the back of President Javier Milei’s strong showing in Argentinian legislative elections, and recent conservative momentum in Ecuador.

This regional “blue tide” creates a powerful tailwind for market-friendly policies, and we argue that this will place some moderating pressure on Brazil’s political elite.

As its neighbours demonstrate the success of radical deregulation, the appetite for a “rational right” candidate in Brazil will only strengthen.

Second, valuations remain exceptionally attractive. Despite the noise, the Brazilian equity market continues to trade at a forward P/E of roughly 10x – well below historical averages and global peers.

EM market valuations vs past 10 years – Brazil the cheapest of the major markets
 

Source: FTSE Russell, Factset, HSBC

Momentum in earnings revisions ratios is broadly turning higher
 

Source: FTSE Russell, Factset, HSBC

The “election premium” is already being priced into assets, meaning that any pivot back toward a Tarcísio-led ticket or a credible centrist surge would trigger a massive re-rating.

Historically, when Brazil shifts toward a pro-market administration, the subsequent rallies can exceed 200% in dollar terms.

In summary, while we expect continued volatility through the first half of 2026, the fundamental investment case for Brazil remains intact. We are navigating a period where political pessimism provides a rare window to build positions in high-quality companies at distressed prices.

We remain vigilant but confident that the broader regional trend and the sheer attractiveness of local valuations will ultimately win out over the electoral circus.

Outlook

Emerging market equities have outperformed developed markets for the first time in five years, and by the most since 2017. The backdrop for the asset class is the most positive we have seen for the last decade or more. We expect the monetary backdrop to remain disinflationary for the first half of 2026, with treasury yields and the US dollar expected to continue declining.

Money growth in China is supportive, strong in India, and weak in Brazil, Mexico and South Africa. EM earnings growth is forecast to be 20.5% in 2026, nearly double this year at 10.4% according to Jefferies. On a more cautious note, global money trends suggest an economic slowdown into the end of Q4 and through Q1 2026 making us cautious on cyclical exposure.

Quality investing by first principles

In investing, there is a fine line between discipline and rigidity, or between conviction and stubbornness. Any resilient investment process must be nimble and adaptable enough to weather different market regimes. Investors relying too heavily on static profitability or valuation metrics in their investment process risk getting caught out when structural change takes place.

Screening for returns on equity, low leverage and earnings growth will give you only a very limited snapshot of investment value. Our aim is to paint a far richer picture of the businesses we are analysing.

We are trying to think about value creation in the stock market from first principles. Economic value added (EVA) stock analysis is one of the key tools we use for this. For those who missed it, we wrote about the core elements of EVA investing in a previous monthly, with highlights from that piece below.

EVA helps to cut through the noise and home into whether a business is creating real economic value, and whether the trend of that value creation is strengthening or weakening. Crucially for emerging markets with weaker governance and opaque accounting, headline earnings can mask poor capital efficiency or inflated asset values. EVA cuts through these distortions by focusing on true economic profitability, drilling into the underlying economic strength of a business.

By emphasising value creation rather than headline earnings, EVA highlights when incremental investments fail to cover their capital charge – often an early warning sign of eroding competitive advantage. Further, this approach naturally draws attention to cyclical or structural changes impacting margin compression, rising capital intensity or declining asset productivity, which traditional metrics might obscure.

Below is a rough sketch of how EVA can provide a more robust check of company economics than an approach focused on accounting profitability.

Example: EM Real Estate Development Co.

Accounting view (P/E)
Reported net income: $100m
Shares outstanding: 50m
EPS: $2
Current price: $20
P/E ratio: 10x

On the surface, ABC Realty looks attractively valued at 10x earnings, suggesting a cheap stock relative to peers trading at 12–15x.

Economic value added view
NOPAT (Net operating profit after tax): $120m
Invested capital: $1.5bn
Weighted average cost of capital (WACC): 12%
Capital charge: $180m (1.5bn × 12%)
EVA = $120m – $180m = –$60m

Despite positive accounting profits, the company is destroying economic value, earning less than its cost of capital. This signals that growth funded by debt and equity is not creating shareholder wealth, even though the P/E ratio looks attractive.

In this case, the EVA approach provides a better assessment of whether a company’s moat remains intact and whether its strategic positioning continues to justify its valuation.

Below is a brief example of what we love to see from an EVA perspective.

Stock example – Vivara: market leader in Brazil’s jewellery industry, vertically integrated and expanding aggressively

Vivara is the dominant retail jewellery brand in Brazil, controlling more than 20% of the market.

Source: Vivara Investor Relations 2025

The business is improving its returns on capital through new store openings, sweating assets and maintaining cost control through scale as the only domestic player which manufacturers its own products.

Sweating the assets harder than peers
Retail space productivity (EUR 000s for sale/m²) correlates with EBIT margin (%) – Global players

Retail space productivity (R$ 000/sqm) correlates with EBIT margin (%) – Local players

Source: BTG Pactual 2024

Value creation highlights:

• Opening 50–70 stores per year, focus on aspirational Life brand, forecast 40% of sales by 2026.
• 2-year sales CAGR of c.18% and EBITDA CAGR c.19%. Same-store sales growth consistently positive.
• E-commerce 23% of total sales, headroom for further growth.
• Plans to enter new markets Mexico and Panama, leveraging scalable business model.

Return drivers and competitive advantage:

• Vertical integration: Vivara controls the entire value chain from design to production and distribution, enabling cost efficiency and rapid response to market trends.
• Brand strength and market position: Strong brand recognition and customer loyalty, 75% retention rate and a broad product range catering to multiple segments.
• Scale and retail network: Extensive retail network with 40% penetration in premium malls and significant opportunities for further expansion.

Our kind of business – this all translates into an attractive EVA profile

Vivaras ROIC charts

Source: NS Partners and Bloomberg

As emerging markets show renewed strength, our approach remains rooted in first principles: seeking resilient, capital-efficient companies positioned for long-term value creation that should drive stock prices.

Considering the importance of structural liquidity in emerging market investing

We argue that a narrow focus on company fundamentals leaves investors increasingly exposed to powerful external forces like structural and cyclical liquidity shifts.

These forces influence capital availability, investor behaviour and asset pricing, often overriding fundamentals in the short to medium term.

Below, we run through two EM-specific examples of how we think about structural liquidity, along with a brief comment on market structure globally.

China’s National Team steps in as foreign investors hit eject

The “China is un-investable” doldrums from early 2021 to the beginning of 2024 saw the MSCI China Index drop from a peak to trough by over 50% in USD terms. Haphazard regulatory clampdowns on the technology and education sectors, a collapsing property market, and Sino-US tensions saw foreign investors run for the exits.

At the peak of the revulsion, we saw many liquid and high-quality companies being dumped, seemingly irrespective of fundamentals. For us, this was a painful experience with many of our favourite names caught up in the stampede. It was also a valuable lesson about the impact of what we call structural liquidity in markets and its power to create extended and sharp periods of disequilibrium where prices appear completely detached from fundamentals.

In our process, we define structural liquidity as the long-term, underlying availability of capital within a financial system or market. Unlike short-term liquidity (which can fluctuate daily), structural liquidity is shaped by:

• The depth and breadth of financial institutions
• The regulatory environment
• The savings rate and capital formation
• The presence of long-term investors (e.g., pension funds, sovereign wealth funds and other state-linked allocators)
• Factors outside of a given country – i.e. pressures on foreign allocators to shift exposure

Our clients are very familiar with our work analysing monetary cycles, with the aim of anticipating economic and market environments over the next year or so. This is a powerful tool for understanding the prevailing investment backdrop and how we expect it to evolve.

Structural liquidity gets less coverage, but understanding this factor can be just as impactful for performance, especially at extremes. Analysing the evolving composition of a country’s financial markets can provide insights into how changes in liquidity flows may be felt across asset classes.

Through the China doldrums, structural liquidity was working against us. Foreign investors were more heavily weighted to higher-quality companies, aligned with our stock picking bias. As these investors yanked funds from the market, we saw favoured names get cut down regardless of the fact that many of these business were fundamentally well positioned to weather China’s weak economy and geopolitical turbulence.

At the same time, state allocators in China (the “National Team”) were instructed to support the market. The reflex for these institutions was to buy ETFs loaded up with state owned enterprises (SOEs). This created an odd dynamic where more economically sensitive, highly indebted and relatively poorly governed companies (including distressed banks and property companies) were dramatically outperforming quality companies in an economic slump.

Investor flows and their composition had a huge impact on returns through much of the 2022–2024 period. In hindsight, the optimal strategy to navigate the volatility would have been to reduce the risk budget for “foreign favourites” while increasing the weighting to select SOEs which fit our stock picking framework. Unfortunately, we were slow to pick up the trend and by the time we had a firm grasp of the situation, valuations of our favourite businesses were starting to look incredibly cheap while already robust fundamentals appeared to be strengthening.

We reviewed China exposure in depth and exited a few positions that were exposed to persistently weak consumer sentiment. We also travelled in China extensively to meet with dozens of companies as soon as the country reopened from the pandemic. This helped to accelerate idea generation and generate more competition for capital within our China exposure. The rest was behavioural, with our iterative process of testing and re-testing stock theses and country views underpinning our conviction to stick with a number of out-of-favour companies.

The slump in quality stocks came to an end as Chinese authorities announced monetary and fiscal loosening in September 2024 to stimulate the economy. This was followed by the Deepseek shock in January 2025, which shone a light on Chinese innovation in AI which was progressing rapidly and at a fraction of the cost in the United States. Suddenly, domestic allocators were rushing into Chinese consumer tech stocks leading China’s AI development. Improving liquidity supported a broadening out of the rally, boosting other innovative companies such as battery leader CATL, drug development company Wuxi Biologics and Hong Kong financials such as Futu Holdings.

Structural liquidity is playing an important role in providing fuel for the rally. With China’s weak housing markets and longer-term bond yields recently moving up from record lows, equities have been the default beneficiary of improving monetary trends which has fuelled a liquidity-driven bull market this year.

China nominal GDP* (% 2q) & money / social financing* (% 6m)
*Own seasonal adjustment

Source: NS Partners and LSEG.

So far it has been domestic money within China participating in the rally, with foreign investors yet to return. Global investors will likely want to see Sino-US tensions cool further following the October APEC summit between Trump and Xi where a temporary truce was announced.

China equities flows: domestic vs. foreign investors

Source: EPFR

While it is pleasing to see our investment style come back into favour, we aren’t falling in love with this rally. Any downturn in liquidity would be a signal to reduce exposure. In addition, while our companies have broadly reported well, much of the wider rally this year has come from re-rating.

Source: Jeffries, October 2025

We are wary of chasing momentum in the China AI thematic without support from fundamentals. This is a fragile trade and vulnerable to a stall in money growth in our view.

Beware relying on mean reversion tables in India

India offers a different perspective on the importance of structural liquidity. Indian equities outperformed for years leading into 2025, and yet most EM investors were underweight the market citing rich valuations.

GEMs active vs. passive country allocations

Source: EPFR

While we were certainly mindful of India’s valuation premium to wider EM, the rise of domestic mutual funds driving flows into equities as Indian workers contribute to their pension accounts is a major structural change. We have seen this before in places like Chile or Australia, and once this trend picks up steam it can be dangerous to rely too heavily on your mean reversion tables!

While we did shift to an underweight in India at the end of 2024, the move was modest and largely based on a view that a deluge of IPOs coming to market was soaking up too much liquidity. This factor, combined with high valuations, supported our view that the market looked to be due a period of consolidation after several years of strong gains.

Model GEM portfolio: India strategy macro ratings and weightings

Source: NS Partners

More recently however, agressive central bank rate cuts have fuelled a pick-up in cyclical liquidity, and while it is a near-term headwind, the flurry of IPOs will deepen the market and produce a more vibrant opportunity set. At the company level, earnings growth is set to lead EM for the next few years. While we are happy to wait for the market to come back to us for now, we see no reason to dismantle our India exposure with such a strong structural backdrop and will be ready to add back when the opportunity arises.

Passive dominance and market fragility

Thinking more broadly, we have been reading some eye-opening analysis from market strategist and investor Michael Green on the impact of rising passive dominance in markets. I won’t rehash the whole thesis in detail, but in a nutshell, Green argues that passive investing has fundamentally reshaped market dynamics by inflating valuations of the largest stocks and undermining traditional price discovery.

As index funds allocate capital based on market cap rather than fundamentals, they create a self-reinforcing cycle where rising prices attract more flows, further distorting valuations. This mechanism favours size and trend over intrinsic value and ignores quality companies outside major indices.

Markets become increasingly inelastic as passive share grows and the share of active and valuation-driven investment falls. The outcome is that liquidity no longer scales with market cap. This makes large stocks more vulnerable to outsized price impacts from passive flows.

Therefore, the largest beneficiaries of a constant inflows to passive vehicles could suffer sharp reversals should those flows reverse, exposing the market to volatility and mispricing.

Finally, Green highlights what he sees as an absurdity, being the construction of rigid rule-based investment strategies meant to operate in markets, which are complex adaptive systems. The dominance of this approach to investment is distorting markets and capital allocation which will have negative real-world impacts in magnifying the power of megacap firms and stifling innovation and creative destruction.

Having always considered the impact of structural liquidity in our markets as a part of our process, Green’s work resonates with our team. In our view, it will be crucial going forward for active investors to have an awareness of how rising passive dominance will create distortions in markets and identify the risks and opportunities that will flow from them.