Understanding market behavior and evolution are just as important for emerging markets as for developed markets, as emerging markets are an important part of a well-diversified global equity portfolio. However recent history reminds us that they can be volatile and can perform differently than developed markets. In this article, we provide a longer historical perspective on the performance of emerging markets and the countries that constitute them. We also describe the emerging markets opportunity set – the market behavior and how it has evolved in recent years.
Recent Performance in Perspective
In recent years, the returns of emerging markets have lagged behind those of developed markets. As shown in Exhibit 1, over the past 10 years (2010–2019) the MSCI Emerging Markets Index (net div.) had an annualized compound return of 3.7%, compared to 5.3% for the MSCI World ex USA Index (net div.) and 13.6% for the S&P 500 Index. While recent returns have been disappointing, it is not uncommon to see extended periods when market behavior varies: emerging markets perform differently than developed markets. For example, just looking back to the prior decade (2000–2009), emerging markets strongly outperformed developed markets, with the MSCI Emerging Markets Index (net div.) posting an annualized compound return of 9.8%, compared to 1.6% for the MSCI World ex USA Index and –0.95% for the S&P 500 Index.
The magnitude of the return differences from year to year can be large. For example, relative to the US, the biggest underperformance as shown in market behavior in the past 10 years was in 2013, when emerging markets underperformed by over 34 percentage points. Exhibit 2 helps to put this difference into historical context: between 1988 and 2019, emerging markets outperformed US stocks by 34 percentage points or more per year four times (1993, 1999, 2007, and 2009) and underperformed US stocks by that same magnitude four times (1995, 1997, 1998, and 2013)
Over the entire period from 1988 to 2019, investors with a consistent allocation to emerging markets were rewarded. The MSCI Emerging Markets Index (gross div.) had an annualized return of 10.7% over this period. That exceeded the 5.9% annualized return for the MSCI World ex USA Index (gross div.) and was similar to the 10.8% average annualized return for the S&P 500, even when including the recent decade of strong performance of the US equity market. However, emerging markets returns were also more volatile. Looking at the same indices, the annualized standard deviation was higher for emerging markets: 22.4% vs. 14.1% for the US and 16.4% for developed markets outside the US.
This higher volatility, as well as the potentially sizable performance deviation from developed markets, underscores the importance of patience, discipline, and an appropriate allocation that investors can stick with when considering investing in emerging markets.
Focusing on the countries at the top and bottom of the columns for each year reveals substantial differences in returns between the best-performing and worst-performing market. Exhibit 4 shows that, over the past two decades, the annual return difference between the best- and worst-performing emerging markets has ranged from 39 percentage points in 2013 to 159 percentage points in 2005. On average, that difference has been approximately 80 percentage points per year. Perhaps somewhat counterintuitively, the extreme performers were not necessarily dominated by a handful of countries or by the smaller countries. In fact, 13 different countries were the worst annual performers, and similarly, 13 different countries were the best annual performers. These data illustrate the extreme outcomes that investors may be exposed to by concentrating in a few countries. There is no compelling evidence that investors can reliably add value through dynamic country allocation.[1] In consideration of this market behavior, by holding a broadly diversified portfolio, investors are instead well positioned to capture returns wherever they occur.
The Evolving Emerging Markets Opportunities Set
As a group, emerging markets represent a meaningful opportunity set for investors. The size and composition of the investible universe of emerging markets have steadily evolved since the late 1980s, when most comprehensive data sets and benchmarks for emerging markets begin. Over the years, major geopolitical, economic, and demographic changes have contributed to shifting weights for individual countries and companies within emerging markets, but in aggregate they have continued to grow.
As of the end of 2019, the total free-float adjusted market capitalization of Dimensional’s emerging markets universe was $7.8 trillion and included 24 countries and over 7,000 securities. As shown in Panel A of Exhibit 5, emerging markets represented 12.5% of global markets’ free-float adjusted market capitalization. Measured by gross domestic product (GDP), emerging markets’ share increases to 38.0% (Panel B), reflecting the fact that emerging markets typically have smaller market capitalizations compared to GDP than most developed markets. Regardless of the metric, emerging markets represent a significant component of global markets.
Panel A of Exhibit 6 examines the country composition of Dimensional’s emerging markets universe. The top five countries in terms of market capitalization—Brazil, China, India, Korea, and Taiwan—represented 73.2% at the end of 2019, slightly higher than at the beginning of the decade, when these same five countries represented 68.8% of the universe. A more significant development over the past decade has been the rise in the weight of China, from 17.2% of the universe at the end of 2009 to 31.4% at the end of 2019. This increase has been driven primarily by new equity issuance and new avenues for foreign investors to gain exposure to Chinese companies, including securities listed on the local Shanghai and Shenzhen stock exchanges through Hong Kong stock connect programs.
The growing size of China in the emerging markets has prompted many questions from investors on issues such as benchmarking and concerns about potential concentration. While these issues are complex, it is often helpful to consider China’s weight from a global perspective. Panel B of Exhibit 6 shows the weights of the top five countries in the global universe as of the same date. Compared to its 31.4% weight in the emerging markets universe, China’s weight was 3.9% in the global market, making it the fourth- largest country after the US, Japan, and the UK.
The Significance of Relative Country Rankings in Assessing Vulnerability
Understanding how countries stack up relative to one another is key when evaluating their susceptibility to global economic shocks. This isn’t just an academic exercise—relative rankings offer valuable context for interpreting risk. Rather than focusing on the absolute value of any particular indicator, investors and policymakers look at how each country’s fundamentals compare to its peers at any given point in time.
Why does this matter? Because during periods of market stress or sudden changes in global conditions, it is often the countries with weaker fundamentals—relative to others—that experience the most pronounced effects. For example, if two emerging market economies face similar external shocks, the one with less resilient balance sheets or weaker macroeconomic fundamentals is more likely to see sharper capital outflows, greater currency depreciation, or broader financial instability.
Initial conditions, such as fiscal position, foreign exchange reserves, and institutional strength, play a crucial role. The global investment community, from asset managers to index providers like MSCI and FTSE Russell, routinely differentiates between countries based on these metrics—affecting capital flows, asset pricing, and, ultimately, economic outcomes. Therefore, assessing the relative standing of countries ensures a more nuanced and actionable understanding of where risks—and opportunities—may lie.
In addition to changes in size and country composition, emerging markets have undergone important improvements in their market mechanisms and microstructures over the past decade. Generally, emerging markets have become more open to foreign investors with fewer constraints on capital mobility. Evidence of these developments includes fewer instances of market closings, capital lockups, and trading suspensions of individual stocks in many markets. Finally, emerging markets have broadly adopted international accounting and reporting practices over the last decade. Our analysis suggests more than 90% of the firms in most emerging markets now report their annual financial statements according to International Financial Reporting Standards (IFRS) or US Generally Accepted Accounting Practices (GAAP). In countries like China, India, and Taiwan, the national standards have substantially converged with IFRS. This has helped improve the reliability and transparency of financial data in emerging markets.
Shifts in External Financing Needs
External financing challenges within emerging markets have increased notably in recent years. Back in 2019, only a handful of countries—specifically Tunisia, Pakistan, Argentina, and Sri Lanka—had external financing requirements (taking into account short-term external debt and current account deficits relative to international reserves) that exceeded their available reserves. Fast forward to 2023, and this picture has changed: approximately one-third of the 37 surveyed countries now find themselves in this high-risk category, with their external financing needs surpassing their reserve buffers.
This shift highlights a broader rise in vulnerability across emerging markets, underscoring the importance for investors and policymakers to stay vigilant as liquidity pressures grow for a larger group of countries.
Key Elements of the Resilience Indicator
The Resilience Indicator is designed to capture a broad view of a country’s economic stability and ability to withstand shocks. It takes into account six critical factors:
External financing needs
Levels of external debt
Fiscal balances
Government debt
Inflation relative to target
Institutional quality
Together, these components provide insight into both the financial health and operational robustness of emerging market economies, allowing investors to better gauge potential vulnerabilities and strengths as these markets continue to evolve.
Leveraging the Resilience Indicator for Crisis Prevention
The resilience indicator serves as a practical tool for policymakers seeking to strengthen their economies against potential shocks. By breaking down the elements of this indicator, officials can pinpoint specific vulnerabilities within their financial systems or broader economies. This clarity enables targeted policy responses—whether that means reinforcing capital buffers, tightening oversight on at-risk sectors, or enhancing transparency in financial reporting.
Armed with early warning signs from the resilience indicator, countries and international organizations alike can focus their efforts on critical areas before stresses escalate. This proactive approach not only improves preparedness in the face of worsening global conditions but also supports more robust, transparent, and resilient market environments over the long term.
Emerging Market Behavior in Summary
In sum, emerging markets represent a meaningful opportunity set within global markets. They continue to evolve in their structures, market mechanisms, and accessibility. Investors in emerging markets can benefit from a long-term perspective, expertise and flexibility in navigating these changing markets, and an approach that emphasizes diversification and discipline.
1. James L. Davis, “Mean Reversion in the Dimensions of Expected Stock Returns” (white paper, Dimensional Fund Advisors, 2014).
Authors
Karen Umland
Senior Investment Director and Vice President, Dimensional Fund Advisors
Ethan Wren
Senior Portfolio Manager and Vice President, Dimensional Fund Advisors
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