3 Winners and 3 Losers from Emerging-Market Funds’ Big Rally

Key Concepts

• Emerging Markets: Investments in developing economies, offering potential for high growth but also higher risk.
• Value Investing: A strategy focusing on undervalued stocks, often with lower price-to-earnings ratios.
• Active vs. Passive Funds: Active funds are managed by portfolio managers aiming to outperform the market, while passive funds (index funds) aim to replicate market returns.
• Dollar Weakening: A decline in the value of the US dollar relative to other currencies, often benefiting emerging markets.
• Factor Tilts: Strategies where funds intentionally overweight or underweight specific factors like value, growth, or geography.
• Medalist Ratings (Morningstar): Morningstar’s qualitative, forward-looking ratings for funds, based on fundamental analysis.
• Star Ratings (Morningstar): Morningstar’s quantitative ratings based on past performance.
• Diversification: Spreading investments across different asset classes to reduce risk.
• Asset Allocation: Dividing a portfolio among different asset classes (stocks, bonds, etc.) to achieve specific investment goals.

Emerging Market Funds & Active Management Insights – A Detailed Summary

I. Emerging Market Fund Performance in 2025 & Outlook for 2026

The year 2025 marked a significant turnaround for emerging market funds, delivering their best annual performance in a decade after years of sluggish returns. This outperformance was driven by a confluence of factors: a prolonged period of underperformance making valuations attractive (“they were kind of cheap”), a “sell America trade” fueled by a weakening dollar and concerns over US tariffs, and positive growth stories emerging from certain markets. This strong performance dramatically reshaped five-year performance tables, particularly favoring value-oriented funds.

Looking ahead to 2026, Russ Kennel anticipates continued momentum, citing the ongoing weakening of the dollar and the fact that emerging markets were previously undervalued. However, he cautions that this is not a guarantee and acknowledges the inherent volatility of these markets.

II. Shifting Market Leadership: India vs. China, South Korea & Taiwan

A notable shift occurred in regional leadership within emerging markets. India, previously a “darling” of emerging market investors, experienced a downturn. Kennel attributes this to US trade tensions, a cyclical shift in market favor (emerging markets often see “violent market shifts of leadership”), and disappointing earnings reports.

This decline benefited China, South Korea, and Taiwan. China’s resilience despite ongoing trade tensions and attractive valuations contributed to its rebound. The weakening dollar also played a role.

III. Strategies of Winning & Losing Emerging Market Funds in 2025

Kennel identified key characteristics of winning and losing funds in 2025. A common theme among winners was being overweight China and underweight India.

• Lazard Emerging Markets Equity: Benefited from a value tilt, with successful investments in Chinese tech names like Alibaba.
• Dodge & Cox Emerging Markets Stock & Callway Emerging Markets: These funds successfully incorporated Asian technology stocks (Alibaba, Taiwan Semiconductor) into their value-oriented portfolios, leveraging quantitative screens to identify undervalued growth opportunities.
• Vanguard Emerging Market Stock Index: Lagged due to its higher allocation to India compared to most active funds and its exclusion of Korea from its index, despite Korea’s strong performance. This illustrates the difference between passive and active management in emerging markets, where active managers can more readily adjust to changing market dynamics.

IV. Active vs. Passive Management & the Role of Factor Tilts

The performance of Vanguard highlights the distinction between active and passive funds in emerging markets. Active funds, with their flexibility to adjust allocations, often outperform passive funds in this asset class due to the dynamic nature of emerging market economies.

Funds like GQG Partners Emerging Markets Equity and Artisan Developing World adopt a strategy of investing in developed market companies with significant revenue exposure to emerging markets. While this strategy performed well until 2025, it suffered when emerging markets outperformed the US.

V. Case Study: GQG Partners & the Nvidia Pivot

GQG Partners, managed by Rajie Jane, provides a specific example of how investment decisions can impact performance. Jane’s decision to sell Nvidia in early 2025, believing AI was overvalued, proved to be a misstep, as Nvidia experienced a strong year. This highlights the challenges of market timing and the potential for even skilled managers to make incorrect calls.

VI. Impact on Morningstar Ratings

The significant performance shifts in 2025 will impact Morningstar’s ratings. While fundamental medalist ratings (based on long-term analysis) are unlikely to change drastically, star ratings (based solely on past performance) will reflect the recent outperformance of value funds and the underperformance of growth or US-heavy funds.

VII. Portfolio Allocation & Risk Considerations

Kennel recommends considering emerging market funds as a diversifier within a portfolio, acknowledging their growth potential but also their heightened risks. He suggests allocating a modest amount to emerging markets, recognizing their volatility and the potential for extended periods of underperformance. He would categorize these funds as not quite "speculative" but not a "core holding."

VIII. The Retirement of Fidelity Contra Fund Manager Will Danoff

The discussion shifted to the retirement of Will Danoff, the long-time manager of Fidelity Contra Fund. Danoff is lauded as an “all-time great investor” for his consistent outperformance across various market environments. His success is attributed to his ability to process vast amounts of information, his curiosity, and his willingness to adapt his strategy while maintaining a long-term focus.

Kennel believes that while another manager exactly like Danoff may not emerge, there is still room for skilled active managers to succeed, although the strategies they employ may evolve with market changes. His two co-managers, Asher Anolik and Jason Wner, are expected to continue his growth-oriented approach.

IX. Lessons from Danoff for Individual Investors

Key takeaways from Danoff’s success for individual investors include:

• Maintain Curiosity: Continuously seek knowledge and stay engaged with market developments.
• Embrace Lifelong Learning: Don’t become complacent after periods of success; constantly adapt and seek new insights.
• Understand Industry Trends: Recognize that innovation impacts all companies, not just those directly involved in technological advancements.

Conclusion:

The interview underscores the dynamic nature of emerging markets and the importance of a nuanced approach to investing in this asset class. While 2025 was a banner year, investors should be prepared for volatility and focus on diversification, long-term fundamentals, and potentially, a modest allocation to actively managed funds with a proven track record. The retirement of Will Danoff serves as a reminder of the value of skilled active management, but also highlights the need for adaptability in a constantly evolving investment landscape.