It’s true that over the past couple of years, AI has been a very central theme within emerging market investing. And that’s because emerging markets provide the picks and shovels for AI and all the supply chain is there. And we’ve seen that translate into record earnings, profitability, and even shareholder returns more recently.

EM Earnings Beyond AI

But what people might be missing is despite this very top-heavy concentration in the benchmarks and the dominance of the AI theme, EM is increasingly becoming an earnings story. Even if you strip out Korea and Taiwan, which have printed fantastic earnings on the memory and foundry side, we also see an acceleration in the underlying broader EM space at about 20% plus per quarter. And that is something that makes us very excited.

Because people have been focused on AI, and rightly so given how strong the companies have performed, and because they’ve become a very, very dominant part of the index that people look at, and in many cases, EM investing has occurred recently through passive investing, and Korea and Taiwan are 50% of that, which is really AI. People have really not paid a lot of attention to other companies that continue to compound earnings at a very attractive rate.

What that means is you’re left with companies that are very high quality compounding earnings and yielding returns that are higher than their cost of capital at very cheap valuations. So even if that can be a slower thing to materialize given the concentration, we believe this is a great opportunity to get ahead of what ultimately will be a broadening out of performance across emerging markets. And fundamentals will eventually prevail, and these companies will appreciate in value.

VanEck’s EM Selection Criteria

We like to see the resilience of earnings. So companies that compound earnings time and time again with a high level of visibility and duration definitely deserve a higher valuation and a higher rating than others that tend to be more cyclical. And at the same time, in general, our philosophy is to look for structural growth that is persistent over time and find companies that can really, on a persistent basis, print returns on invested capital that exceed their cost of capital.

And oftentimes we can find that in spaces like healthcare, like financials of different segments, like other infrastructure plays. So emerging markets are actually quite abundant on these kinds of companies.

Macro Headwinds in Focus

We started the year with a very healthy environment and emerging markets, with a softer dollar, interest rates going down globally. And obviously, we’ve hit a few bumps on the road with the Iran war, and then followed by that, a higher and more stubborn inflation, which means that you’re also now seeing a reverse in the direction in interest rates in developed countries, particularly the US. And that also came with a stronger dollar.

So while that doesn’t derail the EM earnings story, it definitely makes the liquidity in emerging markets and the ability of very disciplined central banks, I must say, across EM, to have a little less room to maneuver in terms of bringing down their own interest rate cycles.

And the other thing is obviously geopolitics is something that we always have to continue to monitor. So there are some top-down risks that we’re mindful of that can have implications on currency and required rate of returns or cost of capital across markets. But the earnings story we think is quite resilient, and we continue to be excited about that.

“The earnings story we think is quite resilient, and we continue to be excited about that.”

We are very encouraged by the fundamentals of AI and the resilience of the supply demand dynamics in emerging markets that represent the picks and shovels of AI. And we are encouraged also by the capital return story that’s coming from that. But at the same time, we believe that with the dominance of that theme that continues to be strong, we are not seeing the market recognize some of the other attractive opportunities that are driven by accelerating earnings across the emerging market space. So we think AI can continue to do well, but we can see a broadening out of performance backed by very strong EM earnings beneath the surface.

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