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CONTRIBUTORS

Tom Nelson, CFA, CAIA

Head of Market Strategy
Franklin Templeton Investment Solutions

Miles Sampson, CFA

Head of Asset Allocation Research,
Franklin Templeton Investment Solutions

Siddharth Chatterjee, CFA

Portfolio Manager
Franklin Templeton Investment Solutions

Ian Westley, CFA

Senior Research Analyst
Franklin Templeton Investment Solutions

Emerging markets (EMs) have lagged global indexes for over a decade due to structural challenges that have slowed growth, contributed to inflation, limited policy options and weakened corporate performance.

As investor attention turns to 2026, we believe EMs have finally entered a phase in which macro conditions, policy flexibility and corporate behavior are aligning in exciting ways, that could drive a sustained improvement in earnings quality and capital efficiency. The outperformance of EM equities during 2025 is evidence of this.

Powerful global themes such as artificial intelligence (AI), de-dollarization1 and trade dynamics are reinforcing this transformation, changing the accepted investment calculus and increasing the prominence of EM assets in allocation decisions.

This is all happening at a time when EM equity valuations appear inexpensive relative to their developed market (DM) counterparts. On a 12-month forward basis, the FTSE EM Index trades at 15.7 times earnings, a 31% discount to DMs.2

As we discuss in this paper, EMs are entering a new phase in which macro-stability, policy flexibility and structural reform are aligning with major global paradigm shifts to drive growth. AI demand, de-dollarization and supply-chain reorientation are all helping to increase the importance of EMs to investors, a trend underpinned by improving earnings quality, stronger balance sheets and more durable growth transmission.

For EM equities, the opportunity centers on rising returns on equity and falling costs of equity. Governance reforms, disciplined capital allocation, increased dividends and ongoing buybacks are enabling a potential valuation uplift. For EM debt, the appeal lies in disinflation, improved policy credibility, stronger fiscal positions and declining tail risks. These dynamics support carry, duration upside and tighter spreads, especially in local-currency markets.

We believe the recent strength of EMs has led to some pockets of overvaluation and concentration risk, particularly among mega-cap technology names, but significant value remains across the asset base. Active management can help access that value and deliver positive returns for investors who have EM exposure within their portfolios.

EndNotes

  1. De-dollarization – reducing the use of US dollars as a global reserve currency.
  2. Source: Analysis by Franklin Templeton Investment Solutions (FTIS). Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

 

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Performance of the fund may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors.

Equity securities are subject to price fluctuation and possible loss of principal.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. To the extent the strategy invests in companies in a specific country or region, it may experience greater volatility than a strategy that is more broadly diversified geographically.

There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Hong Kong and Taiwan could be adversely affected by its political and economic relationship with China.

Large-capitalization companies may fall out of favor with investors based on market and economic conditions.

Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

WF: 8130258

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