Global Capital Reallocates: The Rise of Emerging Markets ETFs in a Shifting Geopolitical Landscape

The global investment landscape is undergoing a seismic shift as capital flows increasingly gravitate toward emerging markets (EM) ETFs. In 2025, Europe-domiciled global emerging market equity funds recorded their strongest quarterly inflows since Q1 2023, with EUR 9.1 billion entering the space between July and September alone. This surge has propelled total annual inflows to EUR 11.6 billion, underscoring a broader reallocation of assets from developed markets to EMs. Passive strategies, particularly index funds, now dominate 45.4% of total assets in the global emerging markets equity category, up sharply from 32% five years ago, according to a Morningstar report. This trend reflects a confluence of macroeconomic tailwinds and geopolitical recalibrations that are reshaping investor priorities.

Macroeconomic Tailwinds: The Weakening Dollar and Valuation Arbitrage

A key driver of this capital reallocation is the weakening U.S. dollar, which has bolstered EM currencies and made EM equities more attractive to foreign investors. The dollar's decline, coupled with uncertainties over U.S. trade policies and inflationary pressures in developed markets, has created a valuation catch-up for EM assets. For instance, the Morningstar Emerging Markets Index has surged 13.7% in euros since the start of 2025, according to the Morningstar report, outperforming developed market benchmarks. This outperformance is not merely cyclical but reflects structural shifts, including improved corporate governance in EM markets and a rebalancing of global supply chains.

Geopolitical Dynamics: Trade Tensions, Energy Shifts, and Central Bank Policies

Geopolitical risks in 2025 are intensifying, yet they are paradoxically fueling EM ETF inflows. U.S.-China trade tensions, while creating short-term volatility, have spurred diversification strategies among EM governments. For example, Asia-Pacific nations are implementing policies to secure access to critical minerals, reducing reliance on U.S. or Chinese supply chains, according to a SP Global analysis. Meanwhile, energy security concerns-exacerbated by geopolitical conflicts in the Middle East-have pushed EM countries to invest in renewable infrastructure, creating new growth corridors.

Central bank policies are another critical factor. EM central banks are aggressively cutting interest rates to stimulate growth, even as the Federal Reserve remains on hold. This divergence has made EM bonds and equities more attractive, with EM growth projected to slow to 2.4% annually in the second half of 2025, according to a J.P. Morgan Research outlook. The weaker dollar further amplifies this appeal, as EM currencies appreciate against the greenback, boosting export competitiveness and reducing debt burdens.

Institutional Strategies: Passive Dominance and Active Innovation

Institutional investors are adapting to this new reality by leveraging both passive and active ETF strategies. Passive ETFs, which now hold 45.4% of EM equity assets, according to the Morningstar report, benefit from low costs and broad diversification. However, active ETFs are gaining traction, particularly in North America, where they accounted for 27% of flows in 2024, according to a State Street 2025 ETF outlook. These products offer flexibility to navigate fragmented markets and capitalize on regional opportunities, such as India's digitalization-driven growth or Brazil's resilience amid trade policy adjustments, according to a Vaneck blog.

A modernized "Washington Consensus" is also emerging, emphasizing productivity-enhancing reforms in EM countries. Structural reforms addressing the "middle-income trap"-such as improving infrastructure, education, and regulatory frameworks-are critical to sustaining the current rally, according to a SSGA policy note. Investors are increasingly prioritizing EM markets with strong policy frameworks, recognizing that long-term growth hinges on microeconomic fundamentals, not just macroeconomic conditions.

Regional Case Studies: Brazil and India as Winners

Brazil and India exemplify the potential of EM markets in this reallocation. Brazil's MSCI Index surged 13.3% in Q2 2025, according to the Vaneck blog, benefiting from moderate U.S. tariff adjustments and a robust agricultural sector. India, meanwhile, has become a magnet for capital due to its domestic consumption boom, government-led manufacturing initiatives, and digital transformation. These markets highlight how EM economies can thrive even in a fragmented geopolitical environment, provided they implement reforms that enhance productivity and attract foreign direct investment, according to the SSGA policy note.

Risks and the Road Ahead

Despite the optimism, risks persist. Geopolitical shocks, such as renewed U.S.-China trade wars or energy market disruptions, could trigger short-term volatility. Additionally, EM economies must avoid complacency; the current rally depends on sustained policy reforms and structural improvements. Investors should also remain cautious about overexposure to single markets or sectors, as diversification remains a cornerstone of EM ETF strategies.

In conclusion, the rise of EM ETFs in 2025 reflects a strategic reallocation of capital driven by macroeconomic shifts and geopolitical recalibrations. As institutional investors increasingly adopt a balanced approach-leveraging passive efficiency and active agility-EM markets are poised to play a central role in the global investment narrative. However, success will hinge on the ability of EM governments to implement reforms that transform cyclical gains into sustainable growth.