Throughout 2016 and 2017, the emerging markets staged an impressive rally. The MSCI Emerging Markets Index surged more than 60%. But since hitting a peak in late January, the index has slid roughly 10%. A rebound in the dollar, which always creates an immediate headwind for emerging market stocks and bonds, is the key culprit. An increase in global trade tensions and an upward move in interest rates have brought further pressure.

But those near-term headwinds are obscuring a much more powerful dynamic in place for EM countries: robust GDP growth. The global economy remains firmly ensconced in a synchronized recovery and is poised to grow 3.9% this year, according to the International Monetary Fund. Emerging markets are expected to expand by a more robust 4.9% in 2018, and that figure surges to 6.5% for markets in Asia.

“This is the ideal global environment for EM equities to perform well,” says Gerardo Rodriguez, portfolio manager of the emerging markets group at BlackRock. “These economies are at a much earlier stage of the growth cycle than developed markets.”

Ed Kerschner, chief portfolio strategist at Columbia Threadneedle, suggests there is a direct relationship between relative GDP growth rates and emerging market performance. The GDP growth in these countries began to accelerate faster than developed markets in 2016, when their GDP was 2.7 percentage points ahead, the first increase in the GDP growth rate differential since 2011.

“And the differential should remain in place in coming years,” says Kerschner, citing IMF forecasts. He cites a still-large gap in productivity rates as a key factor in further strong growth.

For example, the output per worker in developed markets now exceeds $100,000 per year, while it’s less than $20,000 per year in the emerging countries. “There is so much more room for emerging markets to boost productivity,” Kerschner says.

As productivity and incomes rise, consumers in these countries have become a greater force in their local economies. Earnings for firms in the Dow Jones Emerging Markets Consumer Titans 30 Index, for example, are poised to rise 43% in 2018 (and another 20% in 2019).

Kerschner and his team are especially bullish these days on India, one of the world’s most populous countries. The economy there is on pace to expand 7.3% this year, and at a similar pace in 2019, according to Fitch Ratings, with much of that growth coming from consumer goods production. That should help deliver a boost to the Columbia India Consumer ETF (INCO).

Kerschner also notes that heavy spending on infrastructure is lowering the cost of doing business in India. “A new highway between Mumbai and Delhi,” he says, “will cut transit times for goods from 13 to 14 days to just 16 hours.” The Columbia India Infrastructure ETF (INXX) is one way to glean exposure to this productivity booster.

India, like many other Asian countries, is not able to rely on a large domestic natural resources base. That’s actually a clear positive, according to Heidi Heikenfeld, portfolio manager of the Oppenheimer Emerging Markets Innovators Fund (EMIAX). “Nations without a commodity base have had to think strategically to move up the value-added chain,” she says.

The Oppenheimer fund focuses on small and mid-cap firms that are benefiting from a greater entrepreneurial spark taking root in Asia these days. More than 65% of its assets are invested in technology, consumer and health-care stocks, sectors rife with innovation that are playing a growing role in local economies.

Take “biosimilar” drugs as an example. In India, China and elsewhere, drugmakers are ramping up generic versions of hard-to-synthesize biotech drugs and offering them to consumers at very competitive price points. “This results in more affordable health care in EM countries and worldwide,” says Heikenfeld. The Oppenheimer fund garners five stars from Morningstar (for its Y shares).

BlackRock’s Rodriguez says his firm is especially bullish on Indonesia these days. That country has largely missed out on the emerging market rally of recent years. The iShares MSCI Indonesia ETF (EIDO), for example, has dropped an average of 5% over the past five years. “We think growth will pick up after a recent pullback, and a significant risk premium is already built in,” Rodriguez says.

He adds that Indonesia is among the countries that stand to benefit from monetary easing (a contrast to the monetary tightening now taking place in the U.S. and other advanced economies). He thinks Russia, Brazil and Mexico will also benefit from lower interest rates, which could aid the performance of the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB). That fund, which sports a 0.4% expense ratio, tracks an index composed of U.S. dollar-denominated emerging market bonds.

Indexing Up in China

Of course, emerging country investors focused on Asia need to pay attention to the mighty role that China plays in the region, which continues to provide a solid regional economic tailwind. The IMF forecasts 6.6% growth for the Chinese economy this year.

Even though it’s now the second-largest economy in the world, it still remains vastly under-represented in global emerging market indexes and funds, says Brendan Ahern, chief investment officer at KraneShares Advisors LLC. He adds that the situation “is being rectified as various MSCI indexes are steadily adding more exposure to China’s A shares.” Those indexes (and the funds that track them) will continue to steadily add China A shares exposure over the next five years.

That should provide a boost for Chinese stocks. “MSCI indexes represent $12 trillion in assets held in passive and active funds, and as China exposure grows, fund managers will have to buy a lot more Chinese equities to maintain their benchmarks,” says Ahern. His firm offers a range of China-focused ETFs, including the KraneShares Bosera MSCI China A ETF (KBA), which, according to the firm’s literature, “is designed to track the progressive partial inclusion of A shares in the MSCI Emerging Markets Index over time.”

Debt Is Still Under-Owned

It’s been more than a decade since Argentina defaulted on its emerging market bonds, though many investors remain wary of this asset class. “EM debt accounts for 18% of total global debt, but accounts for a much smaller share of U.S. portfolios,” says Jim Barrineau, head of EM debt at Schroders.

“People think of it as a risky asset class, but that’s not necessarily the case. Default rates aren’t any higher than you’ll find on developed market high-yield bonds.” Yet Barrineau notes that the tide has begun to turn as paltry yields on developed market debt fuel growing demand for emerging debt.

Still, investors need to be cognizant of currency risk. As the dollar has staged a recent rebound, the portfolio manager has begun to shift the mix of bonds in the Hartford Schroders Emerging Markets Multi-Sector Bond Fund (SMSNX) toward dollar-denominated bonds. That fund, which carries a below-average 0.90% expense ratio, mostly targets an equal mix of local-currency debt, along with government debt and corporate debt that are priced in dollars and euros. That leads to lower volatility than what’s found in many other emerging market bond funds, says Barrineau.

Out on the Frontier

To be sure, Asia is also now home to a host of mature economies that are no longer in high-growth mode. Instead, a new wave of countries are now populating the ranks of global growth leaders.

“The growth dynamics in emerging markets are changing very rapidly,” says David Dali, portfolio strategist at Matthews Asia. His firm’s Matthews Emerging Asia Investor fund (MEASX), which holds five stars from Morningstar, has key holdings in nations such as Vietnam, the Philippines, Indonesia, Bangladesh and Sri Lanka.

Dali concedes that in the past, “investors had a tough time accessing these markets, due to a lack of liquidity.” But that’s changing fast. As an example, he notes that in 2005, Vietnam had less than 200 publicly traded firms. These days, that figure exceeds 1,200.

Like other strategists interviewed for this article, Dali is partial to domestically focused firms. “They are much better insulated from global macro concerns such as tariffs or currency risks.”

Bluer Skies Ahead

While emerging market stocks and bonds are often more volatile, they are benefiting from a backdrop of stronger GDP growth, which is fueling rising domestic consumption and productivity gains.