Emerging market equities have for the most part been the disappointment of the post-financial crisis investment landscape.

Despite robust economic growth and intervention by western central banks buoying most asset classes – in the process subduing emerging market bond yields to record lows – the benchmark MSCI index for developing stock markets remains 25 per cent below its pre-crisis peak. The global MSCI World index is 22 per cent off its peak.

This year has brought better tidings, but the MSCI Emerging Markets index has gained only 9.6 per cent so far in 2012. Even Europe’s turbulent bourses have beaten that, with the FTSE Eurofirst climbing almost 11 per cent in 2012.

However, the disappointing performance of the MSCI Emerging Markets index has been largely caused by the limp returns of several of the largest bourses. Brazil, Russia, India and China, collectively known as the Bric countries and for some time the main economic engines of the developing world, have all been laggards of late.

This obscures the robust gains of many smaller markets, such as Mexico and the Philippines, which have both hit record levels recently. Stock markets in Indonesia and South Africa have also touched records of late in local currency terms, although weakening currencies have eroded returns in US dollar terms.

Arjun Divecha, chairman of GMO and head of the asset manager’s emerging markets strategy, attributes this to idiosyncratic challenges in each of the larger developing economies – and the lessons learnt from past crises by the smaller ones, particularly in Asia and Latin America.

“For different reasons, all the Bric countries have had structural and cyclical problems recently,” Mr Divecha says. “These smaller markets, on the other hand, are in a good spot right now.”

In fact, the performance of many smaller emerging market bourses since the financial crisis is comparable to that of “defensive” blue-chip western companies, Goldman Sachs analysts noted in a recent report, despite their cyclical nature.

Goldman attributes these markets’ strong post-crisis performance primarily to the fact that many have proved resilient to turbulence emanating from the eurozone. The lower the correlation to Europe, the better the performance, the analysts concluded.

“This suggests that while the smaller EM equity outperformers may not be defensive in the sense of being independent of the economic cycle, they have demonstrated a defensiveness to the ups and downs of the euro area situation,” Kamakshya Trivedi and Julian Richers write.

In contrast, the smaller emerging stock markets that have underperformed recently tend to be vulnerable to the eurozone crisis.

For example, the exchanges of Poland and the Czech Republic have enjoyed a rally this year, and are regarded as relatively strong, fiscally prudent members of the EU – yet both are down over the past 12 months in US dollar terms.

More broadly, the divergence of emerging markets is a sign that investors are increasingly differentiating between countries and even industries in the developing world, rather than lumping disparate countries into one homogenous group, says Ruchir Sharma, head of emerging markets at Morgan Stanley’s asset management arm.

“We’re done with the era where all emerging markets do well,” says Mr Sharma, author of a book, Breakout Nations, on the next clutch of promising developing countries. “We’re finally starting to see a wide divergence of performance of these markets.”

Mr Sharma’s favoured emerging markets for the next few years are Turkey, Indonesia, Thailand and the Philippines, the last having reached a peace deal with Muslim separatist rebels after 40 years of conflict.

“The Philippines was in the wilderness for a long time and it’s now making a comeback,” he says.

Yet many of these smaller emerging markets will be tested by slower growth in the larger developing economies. Many of the outperformers are exposed and correlated to Chinese growth in particular, Goldman notes.

Ironically, China’s stock market is among the worst performers in emerging markets. Although recent data have nurtured hopes that the Chinese economy is stabilising, the Shanghai stock market has continued to tread water. Either this means that the market is overly pessimistic and could be due for a rally or it is a better reflection of the country’s economic reality, strategists say.

In the latter case, “several smaller EM equity markets with significant leverage to Chinese growth are vulnerable, both in terms of their own growth performance and in their equity markets”, Goldman’s analysts conclude.

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