We called for a brighter outlook for EM equities over a year ago on the prospect of a USD bear market. This is now starting to play out, led by a liquidity-driven bull market in China.

Over the last three years to the end of the quarter, EM equities have compounded at an annualised rate of 19%.

Our markets remain under-owned and boast cheap valuations relative to US stocks. Easing financial conditions should support a recovery in earnings growth.

We are also believers that you can have too much of a good thing, and that emerging markets are a host to a number of attractive structural thematics outside of the AI fervour that are unique to our investment universe.

The rally this year has been focused on the large cap names. To illustrate, the MSCI EM Small Cap Index has returned 16.67% against 28.16% for the large cap index for the year to date.

This is also reflected in the underperformance of smaller and less liquid markets such as ASEAN. As the bull market matures, we expect liquidity to creep out to markets such as Malaysia, which have been abandoned by foreign investors despite having exciting structural investment opportunities. We know from past experience that when investor flows do return, the upside can be dramatic.

Returns across emerging markets have so far been driven by local allocators, with foreign investors largely sitting on the sidelines – although interactions with attendees on our usual conference circuit suggest that this could be about to change.

Korea Value-Up deep dive: SK Square

Corporate Value-Up catalyst alongside tailwind from SK Hynix’s dominance in high bandwidth memory

South Korean equities have surged by over 57% this year to the end of September. The fuel is a combination of exposure to AI infrastructure mania through the country’s tech giants such as SK Hynix and Samsung rallying, ultra cheap valuations and the prospect of a broader market re-rating courtesy of the Value-Up corporate reform drive that is now underway.

Below we provide a deep dive into recent portfolio addition SK Square, which we think is emblematic of the broader upside potential in Korean equities if the government sticks to its reform ambitions.

Overview

South Korea is home to some of the world’s most innovative companies, and yet it is also arguably one of the cheapest equity markets. The dichotomy is down to a poor history of corporate governance in the country, with the economy dominated by vast family-controlled chaebol conglomerates.

These families have historically been more focused on preserving their business empires than looking out for the interests of minority shareholders. However, following in the footsteps of Japan’s stock exchange reforms, South Korea has launched Value-Up to narrow the “Korea discount” and attract foreign capital.

We think SK Square epitomises the sort of opportunity where Value-Up could be a significant catalyst for re-rating. Spun off from SK Telecom in 2021, the holding company’s investment portfolio includes business across semiconductors (SK Hynix), ICT ventures and digital platforms.

Source: SK Square 2025

Focus on the discount to NAV for this holding company – the discount has widened to 55% following a recent correction. This was an opportunity to buy. Management has levers to pull to narrow the NAV discount via more share buybacks, NAV enhancement and dividend payouts.

SK Square is the best in class among the holding companies and is leading peers in efforts to enhance shareholder value. Management quality is high and the board has a majority of independent directors. They were the first holdco to unveil their Value-Up program and appear to be executing the plan well.

The company is already practising cumulative voting rights – this favours minority shareholders who can pool votes to secure board seats (only 6% of companies in South Korea practice cumulative voting).

The disposal of non-core assets will enable SK Square to focus its energy on its best assets in the IT and Communications sectors.

A brief history of the chaebols

Born out of the interplay of historical, economic and governmental forces following WWI and the Korean War, these family-owned conglomerates filled a significant institutional void post Korea’s liberation from Japanese occupation in 1945.

Chaebols were formed out of the sale of assets previously owned by Japan’s government and firms, which accounted for 30% of the Korean economy. These assets were often sold to families and high-ranking officials at a deep discount, with prices based on outdated book values amidst high inflation. Early chaebols like Hanwha, Doosan, Samsung, SK and Hyundai used these assets as the foundation for growth.

The Korean government played a decisive role in shaping the economy since 1961. Under President Chung Hee Park, economic development became a top priority for legitimacy. The government launched a series of five-year development plans which were based on nationalising banks and channelling foreign loans in capital-intensive heavy industries and chemical industries. It allowed chaebols to acquire or establish non-bank financials to provide capital to their affiliates.

Korea experienced chronic capital shortages throughout its development period, particularly after the Korean war. The chaebols could create value by internalizing resource allocation and replacing poorly performing institutions. The absence of supporting industries meant that chaebols often had to vertically integrate to secure necessary parts and raw materials.

While the chaebols were effective vehicles for kickstarting growth, a host of structural issues emerged.

Vertically integrated suppliers, with captive customers, meant the chaebols lacked incentives to be efficient.

Cross-subsidisation across affiliate businesses led to yet more inefficiencies and wasteful allocation of capital.

Internal subsidies via nonbank financial subsidiaries funded unprofitable ventures bypassing traditional banks. This was identified as one of the causes for the Asian Financial Crisis.

Centralised family control over numerous group affiliates even though their direct equity ownership is often a small percentage. This control allows for decisions that serve personal interests at the expense of minority shareholders.

Cross-shareholding – affiliates within a chaebol group own shares in each other, which inflates the apparent ownership stakes and provides a mechanism for the founding family to control the entire group with minimal actual capital investment.

High debt-equity ratios. Chaebols have historically preferred debt over equity financing to avoid diluting the controlling stakes of their founding families.

Unchecked power of chairmen. Chairmen held absolute power over strategic decisions, leading missteps such as ill-conceived diversification strategies e.g., Samsung’s entry into the auto industry.

Ineffective boards. Typically dominated by executive officers and outside directors with close ties to dominant shareholders. They often serve to provide ex-post factor approval rather than independent oversight.

Value-Up aims to tackle these issues, and it is more than just political rhetoric.

The program is supported by both of South Korea’s major political parties in the DPK and PPP. Real reform is underway, including revisions to the Commercial Act mandating director loyalty to shareholders (instead of to “the company”), electronic shareholder meetings for large firms and cumulative voting rights to empower minority investors.

Corporate governance reform – Japan vs. Korea

	South Korea	Japan
Mandatory vs. voluntary	Voluntary	Mandatory
Incentives	Carrots and sticks	Named and shamed
Targeting companies with price to book ratio <1	Financial Services Commission believes PBR helps assess whether or not the issue arises from a low ROE due to a high cost production structure and decrease in market demand.	The company has not achieved profitability that exceeds its cost of capital, or investors are not seeing its growth potential.
Framework	A Value-Up ETF Index has been created. Value-Up adherents to be rewarded with inclusion. Potentially, a special tax regime will be set up for companies increasing dividends.	Companies complying with the new corporate governance rules were publicly named by TSE in early 2024.

 

History of SK Square

Founded in November 2021 via a spin-off of SK Telecom, SK Square intended to focus on ICT investments and become a more growth-and-tech-focussed holding company.

The downturn in portfolio company and DRAM giant SK Hynix in 2023 forced SK Square management to sharpen its focus on the underlying portfolio, much of which was loss making.

SK Group chairman Chey does not have a direct stake in SK Square and the independent board of directors makes it more exposed to shareholder activism. It was the subject of shareholder activism in 2023–2024, led by a London hedge fund (1% shareholding), pushing for the business to release an industry-leading value-up plan which was eventually announced in November 2024.

Company overview

• Operating income (Q2 2025) of 1.4tn won, of which SK Hynix contributed to 1.84tn (20% stake). The ICT portfolio is generating negative operating income of 28.9tn won.

Source: SK Square company presentation Q2 2025

• SK Hynix is 88% of SK Square NAV.

• Other than SK Hynix, SK Shieldus (2% NAV) and TMAP Mobility (1%) are the only ventures making meaningful profits.
• Management said that they will divest 20 or more ventures this year, and the rest in the next couple of years.

Source: SK Square company presentation Q2 2025

SK Square’s NAV discount is beginning to narrow. A recent market correction has given us an opportunity to buy the stock.

• NAV to market cap discount has narrowed significantly from 74% in 2022 to 66% at Q3 2024 since the announcement of its value-up program.
• The discount narrowed to a low of 47% in June, before the KOSPI and SK Square correction.
• While SK Hynix corrected by c.15% from its July peak, SK Square’s share price fell by c.37% from its June peak, with the NAV discount widening to c.55% at the time we initiated our position.

NAV Discount	28/08/25
NAV	44,198
Market cap	19,828
-55%

 

Catalysts

There are strong KPI incentives in place for management if the NAV discount gets to 50%, ROE> Cost of equity at 13-14% and over 1x PB by 2027.

Source: SK Square company presentation Q2 2025

The NAV discount has been narrowed by:

1) Aggressive share buybacks (c.9% of total outstanding). Critically, all shares bought back are to be cancelled. At the March AGM, another batch of buyback of 100bn won was announced on top of the 300bn and 200bn buybacks in 2023 and 2024.

Source: SK Square company presentation Q2 2025

2) Non-core divestments by reducing the number of entities from 43 to 20 this year. They are hoping to de-risk the portfolio, boost cash flows and shareholder returns.

Source: SK Square company presentation Q2 2025

3) Payout of at least 50% of recurring portfolio dividend income to investors.

Source: SK Square company presentation Q2 2025

Our base case is for NAV discount to narrow to 40% over medium term, the historic average of holdco discounts in South Korea.

Source: CLSA, DART

Narrowing the discount to this level implies significant upside in the stock.

In addition, dividends from SK Hynix will amount to 3tn won by 2027, which can be deployed.

They have sold an SK Shieldus (Cybersecurity) stake to a PE fund and the cash received in Q3 2025 (510bn won) could be deployed to further boost shareholder returns.

For the remaining unlisted companies, management is yet to outline plans for further asset sales. More clarity here would boost the stock.

Additional tailwinds may come from the next batch of share buybacks to be announced in Q4. The pace and magnitude will be key. SK Hynix coming back in focus as an AI play is an added tailwind.

Risks

• The board of directors may not go as far as investors expect to sustainably narrow the NAV discount from 75% in 2022 to 50%.
• Disappointment over the cadence and magnitude of share buybacks.
• Chairman Myung is trying to turn some portfolio companies around to be EBITDA positive, but the labour union is in the way. (We are still seeing some progress i.e., portfolio company TMAP turned an operating profit in Q2 2025).
• The pace of divestments could be slower than anticipated, as assets require proper packaging to sell them at a good valuation.
• Volatility in the stock adding to beta to the portfolio.
• An SK Hynix downcycle and share price downturn will trigger a bigger correction in SK Square.

Summary

Overall, SK Square is just one example of how South Korea’s Value-Up program can act as a catalyst for managers to sharpen up capital allocation and sweat their assets harder. Much will depend on the government’s willingness to pressure corporates to continue value-enhancing efforts through further legislative and regulatory reform. The momentum is positive, and if sustained could lead to a full market re-rating.

The broad market in China now trades in line with the long-term average valuations. Which begs the question, is there any fuel left in this rally?

Chinese state-owned enterprises have driven market valuations to their long-term average

Note: MSCI weighted. Source: Jeffries, FactSet

Our kind of businesses remain cheap

Note: MSCI weighted. Source: Jeffries, FactSet

MSCI China private sector is trading at just 14x, close to the -1 standard deviation level and c.15% below the long-term average.

Prior to the recent rally, investors had abandoned quality names despite improving profitability, cheap valuations, increasing buybacks and dividends. We are now seeing start to reverse.

China quality now ahead year to date following years of underperformance

Source: NS Partners and LSEG

Improving returns are fuelling the rally

Source: Jeffries, FactSet. Note: Based on current MSCI ex-fin & REITs universe.

China’s electricity demand is scaling up rapidly, driven by AI, EVs, air conditioning and industrial upgrading. Renewables – especially solar and wind – are central to meeting this demand, with China uniquely positioned to scale capacity.

The rise of renewables necessitates a massive build-out of energy storage (30× increase by 2050) and grid infrastructure.

AI is a particularly powerful driver, with data centre electricity demand set to multiply several times over the next few decades. These trends are supported by robust investment and policy momentum, positioning China as the world’s largest “electrostate” by 2050.

Annual power capacity in major countries – China is on track to add over 500 GW of solar and wind capacity this year.

Source: Berstein and government data (2025)

With rising capacity and increasing penetration of renewables, a massive scale-up in energy storage capacity through batteries will be crucial to ensuring grid stability.

Company spotlight: Contemporary Amperex Technology (CATL) – the world’s largest battery maker

Contemporary Amperex Technology (CATL) is a vital player in providing energy storage to address power intermittency issues as China ramps up zero-carbon renewables. The company boasts a number of competitive strengths supporting sustainable earnings growth:

• CATL’s efficient production lines and scale enable it to be a cost leader with the highest GPM (20%) vs. peers.
• This advantage should be sustained as it continues to expand capacity and grow with its customers (Tesla, Chinese OEMs).
• The company is technologically ahead of the market, and its scale allows it to invest much higher absolute dollar into R&D.

You can see this dynamic in the charts below, with increasing scale unlocking a sustainable R&D edge over the competition, while capex intensity falls and free cash flows improve.

Cash generation

Source: NS Partners and Bloomberg

Working capital

Source: NS Partners and Bloomberg

Pricing power and constant technological innovation through scale is becoming a moat that looks increasingly insurmountable for competitors around the world.

In April this year, CATL announced that it was developing fast-charge technology which can deliver 520km range in five minutes.

Source: Financial Times April 2025

This was followed in May by the unveiling of its Freevoy battery which boasts a 1500km range.

Source: Contemporary Amperex Technology Presentation May 2025.

Fears over weak demand for EVs dragging on battery pricing and trade war concerns have hit the stock in recent years. This is a high-quality company trading at a very reasonable valuation, trading at trough 14.6x fwd P/E multiple.

Source: NS Partners and Bloomberg

CATL is just one example of the kinds of opportunities on offer in China. The exodus of foreign investors from the market has left bargains everywhere among well-run, growing companies with lots of cash, next to no debt, with many buying back shares or announcing aggressive dividend plans.

Our portfolio is full of high-quality compounders across sectors trading at very attractive valuations. While it has been the value names, SOEs, small caps and high dividend stocks that have led the first phase of the China bull market, we think that the real gems in this phase on offer for investors remain cheap and look poised to outperform.

In our December 2024 commentary, we framed investing in Brazil as a high-stakes game of Blackjack. We argued that macro uncertainties such as fiscal deficits and political volatility were the low cards (2–6) which favoured the dealer. While these factors make for a daunting investment backdrop, our view was that these “cards” stood a chance of being dealt out as President Lula’s term progressed toward the 2026 elections. As a result, the proportion of high cards (10–Ace), being Brazil’s economic strengths and its reform potential, would start to rise and underpin an increasingly favourable set up for the player (investor).

Since our December post until August 2025, the deck has run down as October 2026 presidential elections in Brazil approach. As anticipated, the stakes are intensifying: Latin America’s 2025 electoral calendar is heating up, with presidential votes scheduled in Bolivia, Chile, Ecuador, and mid-term elections in Argentina, setting the stage for regional sentiment shifts that could influence outcomes in Brazil.

By the second quarter of 2026, we expect to have a good sense of the deck count and our chances of getting a Blackjack. It is likely that the “risk premium” for Brazilian equities has already peaked and will fall as early polls are released, candidates emerge and policy platforms take shape. This creates a unique window now for measured risk-taking as we await further confirmation on the above, selectively allocating chips (capital) to high-conviction hands where the asymmetry of risks favours the upside.

 Active equity fund redemptions decelerate

Source: Itau BBA (August 2025)

So far, our approach has been assertive but disciplined: avoiding high-rolling bets on speculative names in favour of quality opportunities. This has paid off handsomely so far, typified by outperformance in portfolio holdings like Vivara (a jewellery retailer) and SABESP (sanitation utility), delivering strong returns amid a resilient economy.

Brazilian water utility SABESP returns improving

Source: SABESP Q2 2025 investor presentation

Recent macro and political developments: Improving outlook, but risks linger

Since December 2024, Brazil’s economic resilience, despite the tension between tight monetary policy and loose fiscal policy, is undoubtedly a high card. GDP growth is moderating from 3.4% in 2024 to around 2.2–2.3% in 2025, as high interest rates start biting into activity. However, positives abound: unemployment hit record lows in mid-2025, inflation is easing (expected at 5.0% year-end) and the economy is positioned to weather Trump’s proposed 50% tariffs on non-US imports, thanks to exemptions for key commodities and diversified exports.

Politically, the deck is shifting favourably for investors seeking change. Lula’s approval rating has dipped amid unease over economic stability, with polls modelling runoffs showing him mostly behind right-wing figures like Tarcísio de Freitas (current governor of Sao Paulo State). Former president Bolsonaro himself is sidelined by legal troubles, reducing “anti-establishment” risks. The 2024 municipal elections saw gains for conservative candidates, signalling a potential 2026 swing toward market-friendly policies if a centre-right candidate consolidates support.

This echoes our original thesis: as Lula’s socialist term winds down, extreme pessimism over the economy should fade, creating a disconnect between strong company fundamentals and cheap equity valuations.

Core positions: Delivering as expected, with Q2 2025 earnings validation

Our core Latin American holdings have performed robustly, showcasing consistent top-line growth, improving returns (ROIC/ROE) and strong moats in defensive sectors. This validates our philosophy of steering clear of higher-risk names (e.g., leveraged cyclicals, where low margins and geopolitical exposure have led to underperformance amid prolonged high rates and global uncertainty). Initial signs of a softer local economy – for example, a Q2 retail slowdown – have hit speculative plays harder, reinforcing our quality focus.

The results from Q2 2025 underscore management prowess and support the view that our Brazilian names should be robust amid a volatile macro backdrop: top-line momentum (avg. +15% YoY) and ROIC/ROE improvements (avg. +2–3 pts). We are also excited about emerging opportunities as a “positive count” in the deck for Brazil, an opportunity to add some new names from our opinion list.

 Valuations in Brazil remain attractive

Source: Itau BBA (August 2025)

In a couple of months, our planned trip to the region (with a packed agenda) will allow on-the-ground validation, potentially enhancing conviction in existing and prospective portfolio companies.

Outlook: Calibrating bets as odds shift

As inflation cooling and political fragmentation dissipating act as low cards exiting the deck, the count could tilt toward investors. For now, play smart; global headwinds (Trump tariffs and a US slowdown) and domestic fiscal risks could bust hands. We remain focused on quality amid depressed valuations and are keeping eyes on the 2026 Ace: a conservative presidential win that could unlock multi-baggers. Stay tuned for post-trip updates; this game is far from over.

South Korean equities have been on a rollercoaster over the past few years. In early 2024, we saw exuberance fuelled by the announcement of the Corporate Value-Up program. Many were hoping the country was shaping up to follow in the footsteps of Japan – Super-cheap Korean equities rally on market reform talks

Hopes were shattered by disgraced former president Yoon’s attempt to impose martial law in December – South Korea rocked by president’s attempt to impose martial law

While the situation was precarious, South Korean institutions held firm and Yoon now sits in a Seoul detention centre awaiting trial while Democratic Party leader Lee Jae-Myung decisively won a June snap election on a platform of corporate governance reforms.

South Korean equities rally

Korean equities surged around the election, led by financials and technology stocks. We gradually lifted our underweight exposure to neutral and then a modest overweight through the first half of 2025, leaning into the promise of revisions to the Commercial Law Act and Lee’s support of the Value-Up program.

Source: LSEG Datastream

In our view, a series of policy initiatives pushed by the Lee administration have the potential to lift a host of beaten-down domestically focused names, outlined below.

Supporter of Value-Up

Despite being launched by Lee’s then opposition, his party is a supporter of Value-Up. The initiative, modelled on the Tokyo Stock Exchange reforms aims to narrow the “Korea Discount” by enhancing corporate governance, capital efficiency, and shareholder returns.

By publishing Value-Up plans and following through, Korean companies can access Korean Exchange fee exemptions, gain priority in investor relations events, and other awards to enhance market visibility. Taking these steps will also help to better align South Korean governance standards with global best practice, and in turn attract foreign capital and boost valuations.

Commercial Act revision

The Lee government quicky jumped into action to push through revisions to the Commercial Act, which align with the aims of Value-Up. In early July a revised version of the Commercial Act amendment was passed with support from both the Democratic Party and the conservative opposition as a compromise. This version:

1. mandates that directors balance corporate and shareholder interests;
2. requires electronic shareholder meetings for large listed companies (market cap over 2 trillion won, ~$1.5 billion); and
3. prohibits rejecting cumulative voting requests to empower minority shareholders.

The Cabinet approved these amendments on July 15, 2025, signalling their imminent implementation.

Encouraging more equity investment and less speculative investment in housing

The government is also intent on pushing for a shift in the balance of household wealth (approximately 70% of household assets) from real estate to equities. President Lee’s aim is to channel liquidity away from housing speculation to promote greater stability in the Korean economy, and redirect capital into equities. The idea is that this will fuel investment in more productive sectors such as technology and defence in order to stimulate innovation and economic growth.

Value-Up and revisions to the Commercial Act are key levers to encourage this shift by households into domestic stocks.

Excess liquidity provides fuel for stock market rallies

Source: CLSA

Fiscal loosening

The government is also taking direct action to counter stagnant economic growth. In June the government proposed a KRW30.5 trillion supplementary budget, representing 0.9% of GDP, with KRW10 trillion to be handed out as cash for consumption (equivalent to around USD100-350 per person depending on income).

Portfolio – financials exposure boosted

Our portfolio names in financials and technology in South Korea have rallied this year on hopes for President Lee Jae-Myung’s reform platform. Our position in Samsung Life is a beneficiary of the Value-Up program, and rose 67.7% in USD terms through the second quarter alone on expectations reforms will force the disposal of company holdings in affiliated companies. Samsung Life selling its position in Samsung Electronics would trigger a huge one-off gain which will free up cash to be re-deployed into more productive uses and boost returns on equity. We trimmed Samsung Life to rotate into laggard DB Insurance, which is cheaper and in our view, has greater upside catalysts, being yet to announce Value-Up plans.

Leading bank KB Financial was another strong performer, reporting robust profit growth along with a surprise share buyback and cancellation as well as a higher dividend. The bank trades on a modest 0.7x price to book with a return on equity of 9.7% and rising, as well as a 4% dividend yield.

KB Financial driving ROE higher

Source: KB Financial Q1 2025

… while buybacks continue

Source: KB Financial Q1 2025

… and dividends increase

Source: KB Financial Q1 2025

KB also looks set to benefit from planned fiscal loosening by the Lee government and falling central bank rates boosting loan growth.

More to come?

Shareholder and political pressure on South Korean corporates to address their poor corporate governance records continues to build. Progress will no doubt be slow and incremental, but there is a lot of low hanging fruit the government can pursue including changes to capital, dividend and capital gains taxes to encourage investment and reform simultaneously.

Success in these efforts could well be the basis for a full market re-rating.

We have written extensively in recent months on how monetary and currency signals may be hinting that we are on the cusp of a “virtuous circle” for performance in EM equities. For any who missed it, a few recent pieces below:

Implications of Asian currency tremors

‘Beautiful’ tariffs and the end of exceptionalism

Are emerging markets on the cusp of a ‘virtuous circle’?

This is the most bullish we have been on the outlook for emerging market equities in over a decade.

Recent momentum has been positive, with MSCI EM up 9% to the end of May, part of a broader upswing in markets outside of the United States.

MSCI Price Indices
USD Terms, 31 December 2024 = 100

Source: LSEG Datastream

Macquarie Capital investment strategist Viktor Shvets wrote earlier this month that, in May, EM excluding China recorded the largest net inflow since December 2023. India ($2.3 billion), Taiwan ($7.6 billion) and Brazil ($2 billion) received the largest flows, helping to buck a trend of selling through 2024 and early 2025.

EM ex-China Net Foreign Flows (US$ bn) – strong flow reversal

Source: Bloomberg; Macquarie Global Strategy (May 2025)

Persistent negative outflows over the past decade from EM into the United States have driven what by many measures is an unprecedented valuation gap.

US relative to the rest of the world forward PE and dividend yield

Source: CLSA (April 2025)

Some premium is no doubt deserved given stronger US growth versus the rest of the world post-GFC, along with a better environment for capital and innovation. However, such extreme valuations imply lofty relative future growth expectations and leave US equities vulnerable to negative catalysts.

As John Authers wrote in his Points of Return column for Bloomberg:

Ultimately, EMs benefit most from the decline of US exceptionalism, giving central banks room to cut rates, as noted by Points of Return, and letting fiscal authorities spend without worrying about tanking the currency.

In a world where no one is exceptional, as Macquarie’s Shvets puts it, EMs are no longer penalized. At best, he calls the fall of American exceptionalism a process, not a collapse — creating conditions for a gradual rise in US risk premia while avoiding disorderly asset repricing. Investors will continue narrowing spreads between US and non-US assets, supporting EMU and Japan. Ditto for EMs, especially those with stronger secular drivers, with India, Korea, and Taiwan standouts.

Currency tailwind for EM


Source: NS Partners & LSEG

Winners and losers

Despite being caught up in Liberation Day tariff chaos, MSCI China has returned 13.1% over the same period. Since 2023, China has been one of the strongest equity markets in the world. Despite the rally, valuations in many of the high-quality businesses that we like remain modest.

Source: Jefferies (March 2025)

Having led the way for EM over the last few years, Indian stocks returned just 3% as sentiment moderates.

South Korea bounced 18.7% as domestic political risks eased following the impeachment of former president Yoon Suk Yeol following his failed attempt to impose martial law in December 2024. Former opposition leader Lee Jae-myung was elected to the presidency in early June and will immediately grapple with a contracting economy which has been hit further by US tariffs.

Taiwan has been a laggard, its market flat over the period which includes the DeepSeek shock that hit AI supply chain stocks on fears of lower demand for the hardware used to power the technology.

Stocks in Southeast Asia are yet to fire this year despite being beneficiaries of a falling USD and improving global liquidity. Perhaps investors remain fearful that these smaller, open trading economies risk getting trampled at the feet of the two fighting elephants in the United States and China. In a meeting with our CIO Ian Beattie earlier this year in London, Malaysian Prime Minister Anwar explained what a difficult position his country is in. China is Malaysia’s biggest trading partner and second largest investor, while the United States is its largest investor and second largest trading partner! If trade tensions between China and the United States cool, then these markets should soar.

Elsewhere, South African stocks have boomed, rising 24.4% powered in part by the country’s gold miners, along with a tentative improvement in politics under the ruling national ANC/DA coalition.

Brazil and Mexico have largely avoided president Trump’s ire and have rallied despite challenging political and economic backdrops, up 20.0% and 28.3% respectively.

Huge rallies in Greece (47.5%) and Poland (43.3%) have been driven by a powerful cocktail of geopolitical realignment between Europe and the United States and fiscal stimulus combined with cheap valuations. The most notable catalyst has been Germany’s dramatic policy shift under Chancellor Friedrich Merz. His government has proposed a sweeping €500 billion infrastructure investment plan and a major increase in defence spending. Crucially, the proposal includes exempting defence expenditures exceeding 1% of GDP from the constitutional “debt brake,” a move that would allow for significantly more fiscal flexibility.

Turkey bucked the trend (-15%), the market tanking on news President Erdogan jailed a political rival on trumped up corruption charges. The portfolio is zero-weight Turkey, and we are not tempted by ever cheaper valuations while Erdogan threatens the rule of law.

Finally, the GCC was a mixed bag with Saudi Arabia (-5.2%) hit by a weaker oil price, while the UAE (14.9%) was much stronger.

Caveat

Monetary data in the United States had been signalling a slowdown this summer, and this is now likely to be exacerbated by tariffs with a muted recovery in the latter half of 2025. The best-case scenario for EM at present would be contained US economic weakness, a slowdown in underlying inflation and a sustained pace of rate cuts. The story would be one of a late-cycle catch-up in EM performance, as illustrated by the table below.

Stockbuilding cycle & markets: EM, small caps, industrial commodities lagging – catch-up potential?

Source: LSEG Datastream, own calculations / dating, as at 2 June 2025

We would expect EM to underperform in a hard-landing scenario, although this might be temporary given the lack of prior outperformance, followed by a strong early cycle phase. The chart from CLSA below shows prior phases of early cycle outperformance.

Emerging equities are an early cycle play: EM equity outperformance phases post US recessions

Source: CLAS, MSCI, NBER

Mexico’s scorching rally belies deteriorating institutional quality

Ducking US tariffs and in prime position to benefit from US friendshoring, Mexico has been one of the top performing emerging markets this year. Strong stock picking in our portfolio allowed us to keep up despite an underweight to the country. However, we have used the rally as an opportunity to take profits and increase our underweight on a view that investors underestimate the impact of recent judicial elections.

In June last year we flagged the potential for Morena’s dominance in congressional and presidential elections to expose investors to rising institutional risks – Political risks in EM spike as Indian, South African and Mexican elections surprise:

Crucially for investors, AMLO and Morena are pursuing policies that could threaten Mexico’s institutions. Institutional quality is a key factor in determining whether a country moves up the economic development ladder. …

Investors fear that a strengthened mandate will allow Sheinbaum (or even an outgoing AMLO) to undermine judicial independence,and pursue plans to eliminate autonomous government agencies overseeing telecoms, energy and access to information, as well as weaken electoral supervisory bodies.

Morena under president Sheinbaum pushed ahead with an unprecedented judicial overhaul, with Mexican citizens voting in early June to elect judges including for the Supreme Court. As reported by Bloomberg on the 2nd of June – Mexico Judicial Election Sees 13% Turnout in Historic Vote:

The controversial election asked voters to pick judges among several thousand hopefuls which marked a first of its kind experiment for a large democracy. The judicial overhaul could give Sheinbaum broad influence over a revamped judiciary, the only branch of government the leftist Morena party does not control.

Critics of the process argue that this will undermine the rule of law by injecting more politics into legal and constitutional disputes.

Only 13% of registered voters turned out to participate, tasked with choosing between thousands of candidates, while accounting for specialties while selecting an equal number of men and women.

Politicising the selection of the judicial officers compromises Mexico’s separation of powers between the executive, congress and judiciary. This is a step backward as it undermines the institutional pluralism within the country’s system of government, where different power centres provide checks and balances and ways for the system to self-correct.

Regressive judicial reform coupled with a fragile economy hit by tariff uncertainty, falling remittances from a deteriorating US labour market and deportation fears is the basis for added caution.

Risks are to the downside for Mexico’s industrial production in 2025

Source: GBM (June 2025)

Exposure to Mexico in our portfolio is now c. 1% versus c. 2% for the benchmark.

Given the direction of travel in macro risk, we will debate whether to downgrade our country rating for Mexico further in the coming weeks. We are always seeking competition for capital in the portfolio, and in LatAm we are seeing interesting opportunities emerge in places like Argentina, Peru and Brazil, all competing for risk budget.

Currency intervention across Asia in recent weeks may be yet another signal that we are entering a new investment order. We have written to clients previously that a secular peak in the USD likely occurred at the end of 2022.

Looking back to previous peaks in the 1970s and 1980s under Nixon and Reagan respectively, the dollar provided a powerful signal to investors that the US economy was experiencing major distortions that would force policy intervention.

President Trump’s Liberation Day tariff shock is part of a broader play to reinvigorate the competitiveness of American manufacturing. Another key pillar of the strategy is the desire for a weaker dollar. We are now starting to see this play out in Asian currency markets.

The most dramatic moves were in the Taiwan dollar, which surged by 9% over two trading days, reaching three-year highs and logging its sharpest daily gains since at least 1981.

East Asia currencies vs US dollar
31 December 2024 = 100
Source: NS Partners and LSEG (May 2025)

Currency tremors may signal the start of a broader shift in global capital that could have big implications for which markets out- or underperform going forward. As the Financial Times reported in “The Coming Asian FX ‘avalanche’” (7th of May 2025) quoting Eurizon’s Stephen Jen:

“We have long warned about the ‘Avalanche’ risk for the dollar. There could be USD2.5 trillion worth of ‘snow’ in China and more from the likes of Taiwan, Malaysia and Korea, rising at a pace of USD500 billion a year – we conservatively guesstimate. Only a modest proportion of the very large trade surpluses these countries have earned have been repatriated back home, with the bulk of the export earnings being hoarded by exporters in USD deposits.

“Like in actual avalanches, ex-ante, many might dismiss the warnings, but ex-post, all would admit that it was an obvious risk. We are still waiting for more triggers, but we see the sharp sell-off in USDTWD this week from this Avalanche perspective. We predict there will likely be other sudden lurches lower in USDAsia in the coming quarters. Corrections in USDAsia could pacify the US, as Asia accounts for more than half of all US trade deficit, making this a fundamentally benign development, except for those caught long dollars.

“The overhang of liquid dollar holdings is just too large if the dollar weakens, the Fed cuts interest rates, and China stages a cyclical rebound. In other words, both the push and pull factors that kept the export earnings in dollars outside the home countries in the past years will potentially flip signs in the coming quarters. At the same time, many of those holding long-dollar exposures know very well that the dollar is over-valued.”

Emerging markets love a falling dollar, which is an environment we’ve not seen in over 13 years.

Source: LSEG Datastream

Historically, this has seen EM outperform DM, while the winners and losers within the asset class also rotate. For instance, while the strong dollar environment typically favoured EM exporters, a weak dollar would be a shot in the arm for domestic consumers.

Other markets which could surge are those which the United States permits to manage their currencies against a falling dollar by easing monetary policy. There are a number of other smaller EM economies with managed exchange rates which could enjoy surging liquidity that feeds bull markets in financial assets.

The cleanest example of this currency-liquidity transmission is the Hong Kong dollar peg. When the USD falls, the Hong Kong Monetary Authority intervenes to maintain the HKD peg by buying USD and selling HKD, increasing HKD supply. This surge in liquidity lowers interest rates, stimulates economic activity and can lead to higher asset prices (and inflationary pressures).

Our liquidity analysis should be a powerful tool for identifying the risks of both booms and busts if this trend continues.

It’s all about pricing power for the export winners

While exporter stock prices may pop in the coming months on better tariff news, currency dynamics could be important drivers of future outperformance. Let’s use Taiwan Semiconductor Manufacturing Company (TSMC) as an example at the stock level. The company has previously given clear guidance that every 1% of appreciation in the TWD against the USD is a 0.4 ppt hit to OPM. We roughly model this impact out below to illustrate the currency risk to earnings:

EPS	Q1 25a	Q2 25e	Q3 25e	Q4 25e	2025	Implied PE	Implied share price with 17x	Fr current share px
Consensus	13.9	14.8	15.7	15.5	60.0	15.4	1019	11%
FX Impact (10%+)	13.9	13.7	12.7	12.1	52.4	17.5	891	-3%
FX Impact (15%+)	13.9	13.1	12.1	11.5	50.6	18.2	861	-6%
FX Impact (20%+)	13.9	12.5	11.5	10.9	48.8	18.8	830	-10%

If we assumed a further appreciation of TWD/USD to 25 – a 20% appreciation from where TSMC recently guided (when TWD/USD was 33) – the hit to TSMC’s EPS is around 23%.

If we apply a mid-cycle PE (17x) to the company and factor in the earnings hit from the currency shift, that would take us to a stock price of TWD830 from the TWD950 at the start of May.

Adding to the risk is the unpredictability of tariffs negotiations between the United States and Taiwan. Tariffs above 20% on Taiwan semiconductor exports could be a meaningful hit to earnings. Perhaps authorities in Taiwan are allowing the TWD to appreciate as part of a pitch to avoid tariffs.

Mitigating the risks is TSMC’s immense pricing power. We believe robust demand will persist for the leading-edge chips enabling AI where it has a monopoly status. This positions TSMC to pass through a significant portion of price increases to its customers.

However, players in the more commoditised segments of the semiconductor industry which lack the moats and pricing power will be more vulnerable to hits from tariffs and currencies.