The Rewards of Rebalancing

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Global investors are experiencing an accelerating "great rebalancing" as geopolitics reshapes the global economy and capital markets.
The catalyst: concentrated risk from rising political and policy uncertainty in the United States.
Deeper drivers: fading tailwinds behind US asset outperformance; misalignment between capital concentration and global growth; stronger policies in several emerging market and developing economies; converging risk profiles for advanced and emerging market economies.

With just 4 percent of the world’s population, the US accounts for:
- about two-thirds of global stock market capitalization;
- nearly 40 percent of bond markets.
The US accounts for:
- only 9 percent of global growth;
- 13 percent of trade;
- 15 percent of global economic output on a purchasing-power-parity basis.
The Lucas paradox: global savings have flowed from younger, faster-growing economies to slowing, aging ones, inflating US asset prices and keeping capital scarce where it could diversify risk and raise productivity.

Historic US financial tailwinds now fading and likely to reverse:
- Declining interest rates, lower corporate taxes, quantitative easing, a strong dollar, fiscal indulgence, and a growing share of income flowing to capital over labor previously boosted US assets.
- Foreign investors tripled exposure to US equities to more than $20 trillion over the past decade.
- Evidence of a turn in the strong dollar cycle; weakening dollar increases attractiveness of emerging market and developing economies.
- Room for further cuts to US taxes and interest rates is limited; both are as likely to go up as down given the ballooning deficit and persistent inflation.
- The Federal Reserve is moving toward quantitative tightening, reversing the era of $9 trillion in peak asset purchases.
Historic drivers of US corporate profit growth and valuations:
- "Lower interest expenses and lower corporate taxes alone explain more than 40 percent of the real growth in US corporate profits between 1989 and 2019."
- Lower risk-free rates explain expansion in price-earnings multiples over that period.
Rising concentration and fragility:
- In the past three years, just seven companies accounted for 55 percent of total S&P 500 returns.
- The top 10 companies now make up 40 percent of the index.
- Gradual erosion of the traditional safe-haven status of US Treasurys.

Rebalancing begins at the margin; modest changes in large allocations have large macro impacts:
- Norway’s $2.2 trillion oil fund allocates 53 percent of holdings to US assets; trimming to 40 percent would free about $250 billion for investment elsewhere.
Trillions in pension funds, insurers, and sovereign wealth funds could be redeployed:
- Some capital will flow to developed economies (United Kingdom, euro area, Japan).
- Emerging market and developing economies offer the most opportunity.
Emerging market and developing economies contributions and dynamics:
- They have driven three-quarters of global growth in recent decades.
- China and India alone accounted for nearly half of global growth last year, three times the combined contribution of the US and the European Union.
- India and sub-Saharan Africa will each gain more than 12 million workers every year.
- Labor productivity growth in emerging market and developing economies is about 3 percent, more than three times the average for advanced economies.

Financial markets lag economic shifts:
- Emerging market and developing economies accounted for only about 11 percent of global equity market capitalization and 26 percent of bond markets at the end of 2025.
Closing this gap would be macroeconomically significant:
- Reweighting could plug the annual financing gap of more than $4 trillion and lower financing costs for these economies.
- High cost of capital particularly hinders climate mitigation and adaptation investments.
Convergence of risk profiles:
- Public debt: advanced economies 108 percent of GDP versus emerging market and developing economies 75 percent of GDP.
- Currency volatility and sovereign default rates have converged.
- Several emerging economies now have lower public debt ratios, more orthodox monetary policy, stronger reserve buffers, and greater policy predictability than many developed economies, including the US.
- Political risk in advanced economies (rising polarization and instability) narrows perceived safety differentials.
Conclusion: Emerging economy investments now offer robust returns, limited incremental risk at the portfolio level, and large diversification potential as US outsize returns moderate and concentration risks rise.

Emerging market and developing economies provide structurally different returns (demographics, currencies, politics, policy regimes, sectoral composition) and generally lower correlations with developed markets.
Modern portfolio theory implication:
- Assets should be judged by contribution to whole-portfolio risk and return, not standalone expected return.
- Many "global" portfolios are concentrated bets on US equities, Treasurys, the dollar, and a small group of tech companies.
Rebalancing toward emerging economies can:
- Improve risk-adjusted returns for institutional investors bound by fiduciary duty.
- Lower financing costs for emerging economies, boosting investment, jobs, growth, and supporting a more resilient, low-carbon economy.

Rebalancing is inevitable but timeline is uncertain due to barriers:
- Weak project pipelines;
- Misaligned incentives;
- Perverse regulations;
- Investors’ general unfamiliarity with these markets.
Top policy priorities:
- Remove barriers that slow capital reallocation to emerging market and developing economies.
- Strengthen project pipelines and align incentives and regulations to attract institutional capital.
Expected outcomes:
- Unlock stronger, more balanced global growth;
- Reward investors with higher risk-adjusted returns;
- Potentially begin to address the Lucas paradox.

The Rewards of Rebalancing, SONY KAPOOR, September 2026, F&D Magazine.

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