For traders, the defining characteristic of an emerging market isn't GDP but how its sovereign bonds behave during risk-off events. If bonds sell off alongside equities when volatility rises, it's an EM. If they rally as a safe haven, it's a developed market, regardless of economic metrics.

Contrary to fears of being a crowded trade, EM fixed income is significantly under-owned by global asset allocators. Since 2012, EM local bonds have seen zero net inflows, while private credit AUM grew by $2 trillion from the same starting point. This suggests substantial room for future capital allocation into the asset class.

Contrary to the growth narrative, the MSCI China index returned just 3.4% over the last decade with over 24% volatility. During the same period, the emerging market ex-China index delivered a higher return of 4.8% with significantly lower volatility (17.5%), highlighting structural headwinds in China for investors.

While a stronger growth environment supports EM currencies, it is problematic for low-yielding EM government bonds. Their valuations were based on aggressive local central bank easing cycles which now have less scope to continue, especially with a potentially shallower Fed cutting cycle, making them vulnerable to a correction.

With dollar correlations at elevated levels, finding cheap, clean directional expressions against the dollar is challenging. Sophisticated traders are creating bearish dollar baskets that mix G10 currencies (AUD, NOK) with Emerging Market currencies (HUF, ZAR) to achieve greater pricing efficiency.

Given the known flaws in EM benchmarks (duration, currency, instrument type), it's possible to construct a passive, rules-based strategy to correct them. This 'smart beta' approach can systematically deliver a better Sharpe ratio than the underlying index, even if absolute returns are lower before leverage.

Emerging vs. developed market outperformance typically runs in 7-10 year cycles. The current 14-year cycle of EM underperformance is historically long, suggesting markets are approaching a key inflection point driven by a weakening dollar, cheaper currencies, and accelerating earnings growth off a low base.

While broad emerging market currency indices appear to have stalled, this view is misleading. A deeper look reveals that the "carry theme"—investing in high-yielding currencies funded by low-yielding ones—has fully recovered and continues to perform very strongly, highlighting significant underlying dispersion and opportunity.

The extra return investors receive for taking on risk has compressed globally. For emerging markets, this premium is now negative at -1%, meaning investors are not being paid for the additional risk they're assuming compared to safer assets like government bonds.