Equity markets haven’t yet noticed a narrowing risk gap between developed and emerging markets

Bond markets are reflecting a narrowing gap between developed and emerging market fundamentals. That could mean opportunity, argues Pendal’s Global Emerging Markets Opportunities team

• Historically narrow gap between emerging and developed market fundamentals
• Bond markets are paying attention
• Find out about Pendal Global Emerging Markets Opportunities fund

EMERGING markets are thought of as the riskier end of the equity asset class.

This risk is perceived to come from a variety of interlinked causes:

• Weaker governance and more volatile politics
• Lower economic resilience
• More extreme economic and financial cycles

Certainly the history of the asset class is one of booms and busts, while emerging debt markets have an unenviable history of defaults.

Looking at the world in 2025, though, we think the gap between the fundamentals of developed markets end emerging markets is historically narrow – perhaps narrower than it has ever been.

Developed markets face tighter conditions

The UK, where we are based, is seeing long bond yields gap higher in the face of chronically slow economic growth and a yawning fiscal deficit.

Real disposable income has grown at an annualised rate of only 0.6% since 2008. Despite extremely loose monetary and fiscal policy, GDP growth for 2025 is forecast at only 1.2%.

France is about to lose its third prime minister in 18 months, with no political consensus on how to address excess government debt (currently 114% of GDP) and a large fiscal deficit.

In Japan, inflation has eased pressure on government debt in the short term, but national finances remain extremely strained in the big picture.

The US, of course, is the ultimate developed market from a currency point of view.

But the inflationary effects of tariffs and doubts about the government’s commitment to inflation targeting monetary policy are also stressing markets.

The pattern across major developed markets is one of long bond yields pushing higher even as growth expectations deteriorate.

Bond investors are watching EMs

Meanwhile, many emerging markets have either lower growth and inflation, or higher growth and inflation but with a clear commitment to inflation targeting.

Bond investors are paying attention.

The JP Morgan EMBI Global index of USD-denominated emerging market government bonds is trading at its lowest spread over developed market bonds since 2013.

Borrowers are also reacting. Some more-indebted frontier markets are seeking to refinance USD denominated debt into Chinese RMB to take advantage of lower yields.

Equity investors, meanwhile, are taking a different view.

The 12-month forward price/earnings ratio of MSCI World (the developed markets equity index) has expanded to 21.6x, while MSCI EM Index is priced at only 14.3x.

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Pendal Global Emerging Markets Opportunities Fund

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This EM valuation discount of 33.9% is well below the long-term historical average discount of about 20%.

This is despite the IMF’s GDP growth forecasts for the G7 falling to the lowest non-crisis level since 2002.

What it means for investors

As a team of EM investors with experience going back to the 1990s, we are very aware of the international and domestic political and policy risks in emerging markets.

The last year we saw a coup attempt in Korea, military conflict between India and Pakistan, challenging headlines everywhere around tariffs and trade, and the court-ordered removal of a prime minister in Thailand after less than a year in office.

Still, we believe the political and governance risk gap between emerging and developed markets is narrower than at any time we have seen.

Bond markets are paying attention.

Equity markets are not yet.

We remain very positive on the outlook for emerging market equities.

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
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