Key Takeaways
Emerging markets (EM) are experiencing a powerful resurgence, capturing the attention of global investors after a decade of relative underperformance. Despite representing only 21% of the global equity market, non-U.S. equity ETFs astonishingly captured 51% of all equity flows in February, signaling a significant rotation of capital. The iShares Core MSCI Emerging Markets ETF (IEMG), a bellwether for the asset class, has been a major beneficiary, delivering a remarkable 34% return over the past year, far outpacing the S&P 500's 18% gain. This strong momentum has pushed EM assets, including equities and bonds, to record highs.
This rally is not merely speculative; it's underpinned by several fundamental shifts. A sustained depreciation of the U.S. dollar, robust global growth prospects, and burgeoning optimism around artificial intelligence (AI) are combining to create a compelling narrative for EM. Major asset managers are channeling significant capital into these markets, attracted by what they perceive as more attractive valuations compared to developed economies. The traditional view of EM as a purely speculative growth trade is evolving, with many now seeing an asset class where structural risk has declined and earnings momentum is broadening.
IEMG, with its massive $135.94 billion in assets under management and a low 0.09% expense ratio, offers broad exposure to small, mid, and large-cap stocks across developing economies. Its portfolio is heavily concentrated in China and Taiwan, which together account for nearly 48% of its holdings, alongside meaningful allocations to India, South Korea, Saudi Arabia, and Brazil. This diversified yet concentrated exposure positions IEMG as a key vehicle for investors looking to capitalize on the ongoing EM rally, but also exposes them to specific regional dynamics.
The current trend represents a potential turning point after a decade of dollar strength and U.S. market dominance. Investors are now actively seeking diversification and higher growth opportunities beyond traditional developed markets. This shift is driven by a combination of improving fundamentals, bullish technical trends, and a growing recognition of EM countries' integral role in global supply chains and technological advancements.
The U.S. dollar's sustained decline has been a critical catalyst for the recent surge in emerging market assets, and this trend appears poised to continue. The dollar index (DXY) fell approximately 8% in 2025 and is projected to decrease by another 3% in 2026. This depreciation significantly eases financial conditions in emerging economies, as it reduces the burden of dollar-denominated debt and enhances fiscal flexibility for governments and corporations alike. A weaker dollar makes local currency assets more attractive to international investors, translating into larger dollar returns.
Historically, EM equities have demonstrated a strong inverse correlation with the dollar. From 2002 to 2007, for instance, the MSCI EM index delivered an annualized return of 29% during a pronounced dollar bear market. This historical precedent provides a powerful framework for understanding the current rally. Currency strategists widely expect this dollar weakness to persist into 2026, driven by narrowing interest rate differentials as the Federal Reserve maintains a more accommodative stance relative to other central banks. Franklin Templeton's 2026 outlook explicitly calls for further dollar weakness, noting the currency remains overvalued against most major and emerging market peers.
For investors in IEMG, monitoring the Dollar Index is paramount. A sustained move below 100 would signal continued support for emerging market performance, providing a favorable macro backdrop. Conversely, a rally above 105 could create significant headwinds, potentially eroding returns for unhedged EM investors due to currency volatility. This macro factor is arguably the biggest determinant of IEMG's performance in the coming year, underscoring the importance of tracking global currency movements, especially during Federal Reserve meetings and major economic data releases.
The current environment contrasts sharply with the previous decade of dollar strength, which often constrained EM growth and investment. The "Great Risk Reversal" narrative suggests that repaired external balances, improved sovereign credit quality, and supportive policy cycles in several key EM economies are creating a more durable setup for sustained performance. This shift makes the weakening dollar not just a temporary boost, but a potentially long-term structural tailwind for the asset class.
Artificial intelligence (AI) optimism has emerged as a significant and increasingly dominant driver of emerging market equity performance, particularly within technology-heavy regions. In 2025, exposure to AI themes accounted for over half of EM equity returns year-to-date, illustrating its profound impact. Countries like China, South Korea, and Taiwan are at the forefront of AI hardware demand, with their technology and semiconductor sectors experiencing robust growth. This technological dynamism has contributed to EM equities' resilience, demonstrating smaller drawdowns during periods of global volatility and AI-related anxiety.
Goldman Sachs forecasts EM stocks to return approximately 16% in 2026, partly fueled by strong earnings growth in these technology and semiconductor sectors. Benchmark indices in South Korea, Mexico, and Brazil are already nearing record highs, mirroring the broader EM rally. The AI narrative is no longer solely a U.S. story; emerging market countries are integral to the global AI supply chain, contributing semiconductors, critical metals, and manufacturing capabilities. This integration positions them to benefit substantially from the ongoing technological revolution.
IEMG's portfolio reflects this AI-driven opportunity, with technology representing its largest sector allocation at 30%. Its top holdings include key players in the global tech ecosystem: Taiwan Semiconductor Manufacturing (TSMC) at 11.4%, Samsung Electronics Ltd at 4.5%, and Tencent Holdings Ltd at 3.3%. These companies are central to the production of AI chips, hardware, and digital services, making IEMG a direct beneficiary of the expanding AI ecosystem. The strong demand for semiconductors, in particular, has been a powerful tailwind for the fund's tech-heavy composition.
However, this AI-driven surge also introduces new risks. The rapid expansion of AI, while creating immense opportunities, carries the potential for significant disruption. Some emerging market economies, particularly those with labor-intensive service sectors like India's IT services, could face headwinds as AI adoption accelerates and potentially automates jobs. Furthermore, the concentration of gains in AI-related segments raises concerns about potential overvaluation and market corrections within these specific areas, mirroring some of the speculative fervor seen in U.S. tech giants.
Despite the recent rally, emerging market valuations generally remain far cheaper than U.S. stocks, presenting an attractive entry point for long-term investors. This valuation discount is a key factor drawing significant capital inflows into EM assets. While EM equities and bonds are at record highs, the underlying fundamentals suggest that there is still room for growth, particularly when compared to the stretched valuations seen in some developed markets. The cyclically adjusted price-to-earnings (CAPE) ratio, for instance, often highlights this disparity, suggesting that U.S. stocks may be running too hot.
Capital flows into emerging markets are expected to stay positive, supported by favorable external financing conditions and improving investor sentiment. The narrowing of risk premiums reflects this enhanced confidence. However, this is not a "buy everything" phase; money is selective now. Investors are prioritizing markets with credible policy anchors, improving fiscal positions, and strong, unique growth stories. This selective approach means that while the broad EM index benefits, individual country and sector performance can vary significantly. For example, South Korea has surged, while India, despite its strong growth prospects, has lagged in certain periods.
The disparity in growth rates between Emerging Markets and Advanced Economies is widening, with EMs expected to drive a significant share of global GDP growth. Forecasts indicate these markets will sustain a trend-like growth pace of 3.3% in 2026, powered by strong domestic demand, proactive government policies, and favorable macroeconomic factors. This contrasts with a projected 1.5% growth for Advanced Economies. This growth premium, coupled with lower valuations, makes EM a compelling proposition for investors seeking higher returns.
Beyond just growth, EM offers diversification and resilience. With stronger fiscal frameworks, deeper local markets, and dynamic sectors, these regions are well-positioned for long-term opportunity. Adding EM assets to a portfolio can potentially enhance returns, reduce concentration risk in developed markets, and tap into demographic and innovation-driven forces. The expanding middle class in EM, projected to double from 354 million households in 2024 to 687 million by 2034, underpins long-run consumption in housing, healthcare, education, and digital services, creating sustained demand runways for local companies.
While the tailwinds for emerging markets are compelling, significant risks and headwinds persist, demanding a cautious and selective approach from investors. The very AI optimism driving tech gains creates a double-edged sword. While fueling growth in semiconductor and hardware sectors, AI's potential to automate white-collar jobs could impact emerging markets reliant on services, such as India. The rapid valuation expansion in specific EM tech segments, fueled by AI hype, may presage a correction akin to the dot-com era if expectations outrun reality.
IEMG's substantial concentration in China and Taiwan, which together represent nearly 48% of the portfolio, is a key fund-specific factor to monitor. This creates a high-beta bet on the Chinese economy and U.S.-China relations. When China's stimulus measures boost confidence or trade tensions ease, IEMG can surge. However, when geopolitical friction intensifies or Chinese growth disappoints, the fund suffers disproportionately. The top holding, Taiwan Semiconductor Manufacturing, alone accounts for 11.4% of assets, meaning single-stock risk is material. Investors must closely watch Chinese economic indicators like the official manufacturing PMI and retail sales data, as well as BlackRock's monthly fact sheets for shifts in country allocations.
Geopolitical tensions also remain a significant wildcard. Ongoing fiscal concerns in the U.S., with large deficits and no clear stabilization plan, could lead to disorderly moves in U.S. government bond markets, disrupting global liquidity and impacting EM assets. A sharp rebound in the dollar, potentially triggered by unexpected U.S. economic resilience or shifts in Fed policy, could leave unhedged EM investors exposed to currency volatility. Furthermore, energy markets pose a threat; if geopolitical tensions push crude prices sharply higher, a prolonged period with oil trading above $100 per barrel could accelerate global inflation, slow economic growth, and limit EM central banks' ability to cut interest rates.
Finally, while structural reforms have improved market accessibility in some EM countries, a portion of recent inflows has come from hedge funds and other non-specialist investors whose capital can move quickly when market sentiment shifts. This "hot money" can exacerbate volatility during periods of stress, as seen during past geopolitical shocks. Investors must remain vigilant, understanding that while EM has evolved, it is not immune to rapid capital outflows.
After a stellar 34% run over the past year, the question for many investors is whether the easy money has already been made in IEMG. While the fund is trading at $70.61, slightly below its 52-week high of $77.68, technical analysis suggests there might be more room to run. Some analysts project an upside target of $98 based on measured-move analysis from its 2021-2022 decline and subsequent breakout, while a more conservative Fibonacci extension points to $87-$88. This indicates that IEMG's ascent may be far from over, despite the recent gains.
IEMG offers a broad, low-cost entry into emerging markets, holding 2,674 stocks across technology (30%), financial services (20%), and consumer discretionary (11%) sectors. Its 0.09% expense ratio is highly competitive, making it an attractive core position for diversified portfolios. However, its significant concentration in China and Taiwan (nearly 48% combined) means investors are making a high-beta bet on these economies. This concentration, particularly with TSMC at 11.4%, introduces single-stock risk that warrants close monitoring.
For investors attracted to emerging markets but concerned about the concentration risk in China, the iShares MSCI Emerging Markets ex China ETF (EMXC) offers a compelling alternative. With $13.1 billion in assets and a 0.25% expense ratio, EMXC provides similar exposure while completely excluding Chinese companies. EMXC overweights India, Taiwan, South Korea, and Brazil to fill the gap, resulting in heavier semiconductor exposure but eliminating concerns about Chinese regulatory crackdowns or U.S.-China tensions. While EMXC has underperformed IEMG recently due to China's stimulus-driven rally, it offers a cleaner bet on non-China emerging market growth.
Ultimately, IEMG remains a solid choice for investors seeking diversified exposure to international growth, particularly given its low costs and strong recent performance. The macro factors of dollar weakness and the broadening AI ecosystem appear favorable. However, investors should be mindful of the fund's specific country concentrations and the inherent volatility of emerging markets. A balanced approach might involve a core IEMG holding supplemented by targeted allocations or considering alternatives like EMXC for specific risk profiles.
The emerging markets story is far from over, but it demands diligence. Investors should focus on country-level fundamentals and thematic opportunities, rather than blind optimism. IEMG offers a robust way to participate, but understanding its nuances is key to long-term success.
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