5 Strategies for Risk-Adjusted Returns in Emerging Markets

Emerging markets offer high growth potential but come with risks like political instability and currency fluctuations. To navigate these challenges and maximize risk-adjusted returns, here are five key strategies:

1. Diversify Across Asset Classes: Spread investments across equities, sovereign debt, corporate bonds, and alternative assets like REITs or commodities. This reduces exposure to country-specific or asset-specific risks.
2. Use Benchmarks Wisely: Rely on both domestic and international benchmarks like the MSCI Emerging Markets Index. Avoid over-concentration in a few countries or sectors by understanding benchmark composition.
3. Factor-Based and Active Management: Leverage factor investing (e.g., momentum, value strategies) and active management to exploit inefficiencies in emerging markets. Skilled managers often outperform passive strategies in these regions.
4. Local Market Knowledge and ESG Analysis: Combine insights into local political, economic, and cultural dynamics with ESG (Environmental, Social, Governance) analysis to identify opportunities and mitigate risks.
5. Dynamic Risk Management: Use tools like forward contracts, hedging, and real-time risk assessment models to manage currency exposure, liquidity challenges, and market volatility.

Emerging markets are complex, but integrating these strategies can help investors balance risk and return effectively.

Diversify Your Portfolio Across Multiple Asset Classes

Spreading your investments across various asset classes is a smart way to navigate the ups and downs of emerging markets. While these markets offer plenty of growth opportunities, putting all your money into one type of asset can leave you exposed to unnecessary risks.

Each asset class reacts differently to market events. For example, equities might thrive during economic booms but could take a hit during political instability. On the other hand, sovereign debt often provides stability, while corporate bonds and alternative assets - such as real estate investment trusts (REITs) or commodities - offer a mix of risk and protection against inflation and currency shifts.

David Dali, Head of Portfolio Strategy at Matthews Asia, highlights the importance of this approach:

"Many areas of short-term volatility are country-related concerns. That is why it is important to measure the risk and impact of national and domestic factors on the drivers of investment returns."

Use Domestic and International Benchmarks for Asset Allocation

For U.S. investors, benchmarks are essential tools for shaping emerging market strategies. The MSCI Emerging Markets Index is a popular choice, but it comes with concentration risks. As of December 2024, the top five countries in the Morningstar Emerging Markets Target Market Exposure Index make up a staggering 80% of the index. Additionally, tech giants like TSMC, Tencent, Samsung Electronics, and Alibaba alone account for nearly 20% of the index.

This heavy concentration can be both a blessing and a challenge. For instance, in Taiwan, TSMC represents 49% of the Morningstar Taiwan Target Market Exposure Index. Similarly, in Korea, the top five stocks make up 45% of the Morningstar Korea Index, with Samsung Electronics alone accounting for 29%.

India, however, bucks this trend. Over the past five years, its weight in the Morningstar Emerging Markets Index has doubled, thanks to broad-based growth across multiple sectors. This makes India particularly appealing for investors looking to avoid the risks of over-concentration.

When choosing benchmarks, look for ones that are transparent, investable, and updated daily, with historical data available. A deeper understanding of benchmark composition helps you diversify effectively across asset classes and regions, ensuring a balanced approach.

Compare Asset Classes for Risk and Return Potential

Emerging market asset classes come with varying levels of risk, liquidity, and return potential. Aligning these factors with your goals and time horizon is crucial for building a balanced portfolio.

Here’s a quick breakdown of how different asset classes stack up:

Emerging market equities are particularly attractive right now, trading at a 30% discount compared to developed markets. With GDP growth projected at 4.3% for 2024 - far outpacing the 1.7% growth expected in developed economies - there’s clear potential for long-term gains.

However, liquidity is a key factor to consider. Emerging markets often suffer from underdeveloped financial systems and inconsistent regulations, which can make it harder to quickly sell off assets when needed. This means you’ll need to plan for the possibility of holding onto investments during less favorable periods.

Your allocations should reflect your risk tolerance. For instance, a conservative portfolio might lean toward 40% equities and 60% fixed income, while a more aggressive one could shift to 75% equities and 25% fixed income. Tailor these percentages to fit your age, investment timeline, and financial goals.

The bottom line? Avoid putting too much weight on any single asset class or region. As David Dali points out:

"Stock prices can move for many reasons and often those reasons have little direct connection to the companies with the exception of where that company does business."

This reinforces the importance of spreading your investments across multiple asset classes and regions to manage the unique challenges of emerging markets effectively.

Apply Factor-Based and Active Management Approaches

Emerging markets can be a goldmine for investors willing to go beyond basic index tracking. These markets, rife with inefficiencies and structural gaps, offer opportunities for both factor-based strategies and active management to potentially enhance risk-adjusted returns.

Unlike developed markets, where information moves rapidly, emerging markets often lag behind. This lag - combined with less mature financial systems, lower liquidity, and inconsistent regulations - creates opportunities for investors to exploit mispricings and inefficiencies. By using factor-based strategies, you can navigate these risks more effectively.

Use Factor Investing to Reduce Risk

Factor investing zeroes in on specific drivers of returns that aren't tied to the overall market. In emerging markets, this strategy is particularly effective because factor premiums - like quality, value, and momentum - tend to be more pronounced and persistent compared to developed markets.

Momentum strategies, for instance, have delivered strong results in emerging markets, with annual momentum profits averaging 11.4%. This success is often attributed to slower information flow and behavioral biases that are more pronounced in these regions.

Value investing also holds up well in emerging markets. While value strategies faced challenges in developed markets post-2008, emerging market value stocks have remained robust. For example, the DFA International Value fund (DFIVX) posted a 17.97% return year-to-date through May 2025, significantly outperforming the S&P 500, which saw a modest -0.17% return in the same period.

Johannes Lins, CFA and Portfolio Manager for Equities, highlights the effectiveness of this approach:

"Factor investing in equities has proven effective by systematically identifying and targeting return drivers that are different from the broader market."

Low-volatility strategies also shine in emerging markets by leveraging the tendency for high-volatility stocks to underperform over time. When using factor strategies, prioritize companies with strong profitability, stable cash flows, and disciplined capital allocation - qualities that become even more vital given the varying governance standards in these markets.

Apply Active Management to Generate Alpha

Active management is another tool that can be particularly effective in emerging markets. These markets’ inefficiencies and diverse investment landscape provide skilled managers with ample opportunities to outperform passive benchmarks. With over 3,000 stocks across 25 countries, the investment universe is vast.

For example, tactical decisions by funds like DEFVX (Emerging Value) have led to annualized returns of 9.75%, while DEMSX (Emerging Small) achieved 10.51% over the period 1999–2025. Both funds outpaced the MSCI Emerging Markets index, which returned 7.75% during the same period.

That said, active management comes with trade-offs. Higher transaction costs, management fees, and potential tax implications can eat into returns. However, the ability to pivot quickly in response to political changes, currency shifts, or new opportunities can make active management a powerful tool in dynamic markets.

Compare Passive vs. Active Investment Strategies

When deciding how to allocate your investments in emerging markets, it’s important to weigh the pros and cons of passive and active strategies. Each has its strengths, depending on your goals, risk tolerance, and time horizon.

Passive strategies provide consistency and predictability, making them ideal for long-term investors who prioritize stability. By diversifying across an index, passive funds spread risk effectively and keep costs low, helping you retain more of your returns.

Active strategies, on the other hand, offer the potential for higher returns but require careful selection of managers. While only about 4.1% of actively managed U.S. portfolios consistently outperformed their benchmarks over 20 years (a statistic largely reflecting developed markets), the inefficiencies in emerging markets give skilled managers a better shot at generating alpha.

Ultimately, your choice between active and passive management should reflect your investment goals and risk appetite. If you prefer stability and have a shorter investment horizon, passive funds might be a better fit. However, if you’re willing to embrace more volatility for potentially higher returns, active management could be the right choice. A blended approach can also strike a balance, combining the stability of passive strategies with the growth potential of active management.

Align your strategy with the dynamic nature of emerging markets to make the most of these opportunities.

Use Local Market Knowledge and ESG Analysis

Investing successfully in emerging markets takes more than crunching numbers from afar. The best investors blend local market expertise with a thorough ESG (Environmental, Social, and Governance) evaluation to uncover opportunities while steering clear of potential pitfalls.

It’s not just about financial data. Local political, cultural, and regulatory factors play a huge role in shaping investment outcomes. By combining ESG insights with a deep understanding of local dynamics, investors can better navigate the ups and downs of these markets.

Apply Local Market Knowledge to Investment Decisions

Understanding a market means diving deeper than economic reports. It involves grasping the cultural, political, and business nuances that drive opportunities on the ground. Companies that embrace this approach often outperform those sticking to cookie-cutter global strategies.

Take Coca-Cola in India, for example. By introducing localized packaging and flavors, they captured a larger market share. Similarly, Unilever’s regional operations in Africa helped them mitigate risks and seize growth opportunities. HSBC’s ability to adjust its strategies to align with India’s evolving economic and regulatory landscape is another standout example.

To harness local market insights effectively, keep an eye on key economic indicators, monitor political stability, and familiarize yourself with regional business practices. Partnering with local experts can also provide a clearer picture of the landscape. These insights not only help in identifying region-specific opportunities but also in avoiding potential pitfalls, making diversification and active management more effective.

Include ESG Analysis in Your Investment Process

Once you’ve tapped into local market insights, ESG analysis becomes a critical tool for refining risk assessments. Emerging market investors face 14.2% more unmanaged ESG risks compared to those in developed markets. That makes ESG analysis indispensable for managing these complexities.

Companies with strong ESG practices tend to be better prepared for regulatory changes, environmental challenges, and social disruptions. Research consistently shows that businesses with higher ESG ratings often outperform their peers. A McKinsey study of the world's 10,000 largest companies between 2016 and 2022 found:

"Companies that pursue stronger growth and profitability while improving ESG performance deliver superior shareholder returns." - McKinsey & Company

ESG integration isn’t just about managing risks - it can also reduce portfolio volatility, particularly during economic or social crises. To implement ESG analysis effectively, focus on three key areas:

• Environmental: Look for companies with solid sustainability practices to address climate-related risks.
• Social: Assess labor practices, human rights records, and community engagement.
• Governance: Evaluate measures like board independence, transparency, and anti-corruption policies.

The demand for responsible investment is growing rapidly. By 2024, ESG-mandated assets are expected to account for half of all professionally managed assets globally. For investors, integrating ESG into their strategies isn’t just ethical - it’s a smart way to manage risks while staying ahead of market trends.

Track Key Market and ESG Indicators

To put these strategies into action, it’s essential to monitor both local market conditions and ESG performance systematically. Keeping an eye on the right indicators can help you spot opportunities early and address risks before they escalate. Here’s a breakdown of key metrics to track:

Regularly tracking these indicators can reveal emerging opportunities before they’re widely noticed and flag risks before they become costly. Companies that excel in multiple ESG categories and operate in favorable economic and political conditions tend to deliver the best risk-adjusted returns.

The scale of ESG investment is already massive. According to the US SIF Foundation, $8.4 trillion in U.S.-based assets were managed using sustainable investment strategies by the end of 2021. This growing momentum offers a significant advantage for early adopters of ESG-integrated approaches.

For investors working with advisory firms like Phoenix Strategy Group, the combination of local market expertise and ESG analysis becomes even more impactful. These firms offer deep market knowledge and a strong grasp of regulatory environments to identify businesses that meet ESG criteria and show the operational strength needed to thrive in emerging markets.

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Implement Dynamic Risk Management and Liquidity Controls

Emerging markets come with their fair share of challenges - currency swings, liquidity constraints, and volatile market conditions are just a few examples. To navigate these complexities, investors need systems that respond in real time, providing tools to manage both market risks and liquidity concerns effectively.

So far in 2024, emerging market currencies have dropped about 4% against the US dollar. Latin American currencies have fared slightly worse, falling 5%, while Asian emerging market currencies have seen a 4% decline. Without proper safeguards, these fluctuations can eat into returns, making risk management a top priority.

Monitor Market Volatility and Currency Exposure

Currency fluctuations are one of the biggest hurdles for investors in emerging markets. Historically, a diversified portfolio of emerging market equities has faced currency risks that could reduce returns by 0% to 1% annually - against an expected equity return of 9% to 12%. While these figures might seem manageable, the real trouble shows up during periods of extreme volatility.

To mitigate these risks, forward contracts can be used to lock in exchange rates for periods ranging from three days to a year. Active currency programs combine systematic and discretionary strategies to determine when and how much foreign currency exposure to hedge. Clear, consistent rules for managing foreign exchange (FX) risk are essential. Chris Braun, Head of Foreign Exchange at U.S. Bank, emphasizes:

"For a corporate treasury team, the focus of any currency hedging program should be on the reduction of risk, not on trading the market."

Looking ahead, currency volatility is expected to remain a concern. According to Nordea's 2024 Treasury Survey, 43% of respondents foresee "high" FX volatility between 2025 and 2030, while 53% predict "moderate" levels. Johan Trocmé, the survey co-author, highlights:

"There's quite a consensus among Nordic large corporates that there will be FX volatility in the coming five years. That's an important issue companies will have to address in their risk management strategies."

To stay ahead, investors should analyze their business cycles to pinpoint where FX risk exists and evaluate how sensitive profit margins are to currency shifts. This involves monitoring hard currency shortages and potential liquidity issues tied to currency convertibility in emerging markets.

Build Custom Models for Real-Time Risk Assessment

Traditional risk models often struggle to keep up with the rapid changes and complexities of emerging markets. That’s where custom machine learning models come into play, offering real-time insights that adapt to market shifts and nonlinear relationships. These tools enhance decision-making and provide a clearer picture of risks in volatile environments.

Machine learning is transforming financial risk management. These models can handle diverse data types and uncover complex relationships, making them invaluable for today’s financial markets. Research involving over 6,000 companies across 47 countries found that FX hedging led to lower cash flow volatility, reduced systematic risk, and higher market values. A separate study on U.S. companies revealed that hedging increased market valuation by 4.87%.

Technology plays a key role here. Advanced tools can identify what drives FX gains and losses, offering real-time insights into costs, timing mismatches, and other challenges. Algorithmic trading platforms can automate FX trades based on predefined strategies, while Currency Management Automation tools streamline treasury operations, cut hedging costs, and improve visibility into exposures.

The most effective strategies combine technical analysis with a tailored approach. Automated dashboards that track hedge performance, costs, counterparty exposures, and mark-to-market values help ensure risk models stay aligned with market dynamics. For investors working with firms like Phoenix Strategy Group, these advanced models offer the expertise needed to tackle the unique challenges of emerging markets.

Compare Different Risk Management Tools

Every market condition calls for a specific approach to risk management. Choosing the right tools can make the difference between preserving returns and facing steep losses. Below is a comparison of key risk management tools:

Unhedged portfolios may outperform during stable periods, but they often underperform during market stress. This makes dynamic hedging strategies, which adjust to evolving conditions, a more attractive option. Static hedge ratios might work in the short term but can lead to poor outcomes if not updated regularly to reflect exchange rate changes. As a result, many investors are shifting toward active currency programs that adapt to market realities.

When selecting risk management tools, it’s crucial to consider your investment timeframe and risk tolerance. For liquidity management, strategies like centralized treasury functions, optimized in-country cash management, and accurate cash flow forecasting are key. Policies encouraging early payments, negotiating longer terms with suppliers, diversifying funding sources, and leveraging forecasting tools can help avoid liquidity crunches while maintaining the flexibility to seize opportunities in emerging markets.

Use Advanced Technology and Professional Advisory Services

Investing in emerging markets has taken a leap forward with the use of advanced electronic systems. What used to involve manual processes and high-touch trading has now been transformed by technology that delivers real-time insights and automated risk management tools.

Benefits of Real-Time Portfolio Tracking

The rise of electronic trading in emerging markets has been nothing short of transformative. Back in 2010, nearly all equity trades - 95% - in these markets relied on program trading or high-touch cash desks. Fast forward to 2024, and almost 45% of trades in regions like APAC, Europe, and MENA are now executed electronically. This shift has not only reduced costs but also improved market liquidity.

For instance, execution costs have dropped significantly, from 20.8 basis points in 2015 to just 16 basis points by 2024 - a 23% decrease. At the same time, average daily spreads tightened by 25%, while daily turnover skyrocketed from $20.2 billion to $73.3 billion, marking a 264% increase in liquidity.

Real-time data has become a game-changer for investors, especially in volatile markets. Those using real-time insights can react 4–6 weeks faster than those relying on quarterly reports, often achieving 7–12% better investment performance over time. During the market turbulence of 2020, investors with real-time risk management tools were able to cut their exposure to downturns by roughly 23%.

Integrated financial models that combine real-time data with scenario analysis have proven especially effective. For example, a real estate investment trust (REIT) managing over $3 billion in assets adopted a system that tracked 47 key performance indicators in real time. Within 18 months, this system uncovered $127 million in optimization opportunities - insights that would have been missed with traditional quarterly reviews.

These technologies also allow investors to create detailed outcome scenarios with defined probabilities, enabling sharper decision-making. As one real estate economist pointed out:

"Real-time information gives investors a decisive edge."

Even smaller investment teams are benefiting from these advancements. A 12-person firm specializing in value-add multifamily properties increased its acquisition efficiency by 40% after adopting a real-time data platform. This allowed the team to evaluate three times as many potential deals without adding staff.

While technology has streamlined trading and risk assessment, expert advisory services remain essential for navigating the complexities of emerging markets.

Work with Expert Advisory Firms

Advanced technology alone isn't enough to tackle the challenges of emerging markets. Professional advisory firms bring the strategic expertise needed to complement these tools, helping businesses make informed decisions and scale effectively.

One area where advisory services shine is with fractional CFO offerings. For instance, Phoenix Strategy Group provides fractional CFO services that deliver senior-level financial expertise without requiring a full-time hire. These services guide companies on capital allocation, risk management, and financial planning, all while integrating real-time data across multiple markets for better decision-making.

Emerging market investments also require robust FP&A systems to handle challenges like multi-currency transactions and complex regulations. Advisory firms specialize in designing these systems and developing KPIs tailored to the unique demands of these markets.

M&A advisory services are another critical area. Navigating cross-border transactions in emerging markets often involves regulatory hurdles, cultural nuances, and extensive due diligence. Advisory firms bring the local knowledge and transaction experience needed to structure successful deals. As Chris Matlock, vice president and research leader at Gartner, explains:

"It is the maintenance of risk and the timely response to risk throughout a project's lifespan that has the biggest impact on success."

Advisory firms also play a key role in implementing governance, risk, and compliance (GRC) platforms. These platforms help organizations manage policies, conduct risk assessments, and automate internal audits across diverse markets. Additionally, firms with data engineering expertise can integrate real-time data sources into existing systems, adjust decision protocols, and introduce automated alerts - essential steps for fostering a data-driven approach.

The best advisory relationships combine technical expertise with strategic insight. Firms like Phoenix Strategy Group offer services such as revenue analysis, cash flow forecasting, and unit economics evaluation. They ensure that companies not only adopt advanced technology but also develop the organizational capabilities to make the most of these tools.

When choosing advisory partners, businesses should look for firms that provide structured frameworks to validate data before taking action. Successful partnerships also include change management support, with 15–20% of the implementation budget typically allocated to training and organizational development. This ensures that companies are well-prepared to capitalize on both the technology and strategic guidance provided.

Conclusion

Emerging markets represent a vast investment opportunity, encompassing 82% of the global population but holding only 26% of global market capitalization. This gap highlights the potential for investors who can skillfully navigate the complexities and volatility of these markets.

The five strategies discussed in this guide offer a solid foundation for achieving risk-adjusted returns in these dynamic environments. Diversification across asset classes is key, helping to reduce concentration risk - especially since the top five countries make up 80% of the Morningstar Emerging Markets Target Market Exposure Index. Successful diversification often involves tailoring strategies to local conditions, as seen with regional market leaders.

Active management and factor-based approaches shine in less concentrated markets. For instance, in China, 60% of active funds outperformed passive ones over a rolling five-year period, while in India, 53% of active funds outperformed their passive counterparts over the past decade. As Marco Ruijer, CFA, Portfolio Manager at William Blair, aptly put it:

"Risk management is not about not taking risks. It's about understanding your risks and risk correlations."

Localized strategies and integrating ESG principles further enhance opportunities in emerging markets. Yvette Babb, Portfolio Manager at William Blair, shared:

"Our emerging markets debt team has long seen ESG as fundamental to how we understand sovereign and corporate risk, which we believe helps us deliver risk-adjusted returns."

Additionally, tools like currency hedging and agile risk management play a crucial role in stabilizing returns amid market fluctuations.

The use of real-time data and expert advisory services completes the framework for tapping into the potential of these markets. Real-time portfolio tracking and detailed analytics empower investors to react swiftly to changes, while advisory services, such as those from Phoenix Strategy Group, provide expertise in areas like cross-border transactions, regulatory navigation, and financial planning.

FAQs

What are the best strategies for balancing high returns and risks when investing in emerging markets?

To navigate the risks and rewards of investing in emerging markets, a disciplined and well-thought-out strategy is essential. A good starting point is to diversify your portfolio. Spread your investments across various asset classes, industries, and regions to minimize reliance on any single area or sector. This approach helps cushion potential losses from specific market downturns.

Equally important is gaining a solid understanding of local market dynamics. Stay updated on political shifts, economic developments, and regulatory changes that could affect your investments. To manage risks like currency fluctuations and market volatility, consider using tools like hedging strategies.

Lastly, maintaining a long-term perspective is crucial. Market turbulence can be unnerving, but sticking to a clear investment plan during uncertain times can help you work toward steady, risk-adjusted returns over time.

How does ESG analysis help manage risks and uncover opportunities in emerging markets?

ESG analysis plays a key role in understanding risks and spotting opportunities in emerging markets. By assessing environmental, social, and governance factors, investors can uncover potential risks that might affect financial outcomes and overall market stability. This kind of evaluation supports the development of better risk management strategies while pointing out areas of growth linked to sustainable and ethical business practices.

On top of that, having access to higher-quality ESG data can lead to smarter decision-making and encourage responsible investment choices. Prioritizing sustainability not only helps investors mitigate risks but also promotes long-term, steady growth in these fast-evolving markets.

How do active management and factor-based strategies improve risk-adjusted returns in emerging markets compared to passive investing?

Emerging markets present a unique landscape where active management and factor-based strategies can play a crucial role in enhancing risk-adjusted returns. By taking advantage of market inefficiencies and adjusting to shifting conditions, active managers can fine-tune portfolios, mitigate potential risks, and zero in on performance-driving factors like value, growth, or momentum. This ability to adapt is especially valuable in emerging markets, where volatility and inefficiencies tend to be more pronounced.

On the other hand, passive investing typically follows market indices, which can limit the ability to respond to sudden changes or capitalize on inefficiencies. While passive strategies often come with lower costs, they may lack the flexibility needed to tackle the distinct challenges of emerging markets. For investors aiming to balance higher returns with effective risk management, active and factor-based strategies can provide a meaningful edge.

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