Divergence calls for diversification: Asia’s investors look to Europe

Over more than a decade, many Asian countries have looked beyond their own borders for long-term investment opportunities, with significant amounts of capital being directed towards the US. This year we note that Asian investors are increasingly aiming at rebalancing their portfolios, with European assets deemed as an attractive alternative.

Through the mid-2010s, widening current account surpluses led to Asia’s central banks accumulating large foreign exchange (FX) reserves, fuelling demand for global fixed income assets in general, and particularly US Treasuries. Higher overseas returns and in some cases limited domestic markets also led to a rise in capital outflows out of Asia from corporates, households, and financial institutions. The US equity market’s superior earnings growth and its significant bond capital markets’ liquidity and depth made US assets a distinct beneficiary.

This rise in foreign asset holdings - and especially in US dollar-denominated assets - has been impressive. Asia’s gross international investment position has doubled in the last 13 years, to US$46trn as of the first quarter (Q1) of 2025¹  and is spread across equities, government bonds and credit, foreign direct investments, FX deposits, loans and reserve assets. Of that $46trn tally, Asia’s securities portfolio, including securities holdings within reserve assets – those controlled by central banks - represents $21trn. By another measure, Taiwan is currently holding more than 100% of its GDP in dollars, followed by Japan at 68% and South Korea at 40%.¹

Notably, a recent sharp rise in the local currency and a fall in the dollar reduced the value of unhedged investment assets relative to their liabilities for Taiwan life insurance companies, impacting their bottom line and threatened their solvency.²  To put this into perspective, Taiwan's overseas assets totalled $1.7trn as of May 2025. Of that, some $750bn represents investments in foreign bonds by life insurers, mainly Treasuries and corporate debt.³

A rebalancing shift

Asian investors’ overallocation to US assets, or dollar bias, has certainly been a long-standing trend, but market conditions and investor sentiment are now shifting towards rebalancing. The US administration’s “America First” policies, as well as divergent monetary and fiscal policies are gradually weakening the links between global economies, with investors increasingly recognising the value, and need, for international diversification. In addition, a weaker US dollar has caused ever-rising pressure on Asian countries with large US holdings.

There has been a notable shift in investor desire to diversify into Europe, as European equity markets outperformed their US counterparts for a large part of this year. This outperformance has challenged the long-standing narrative of US market dominance and opened new opportunities for investors looking to diversify their portfolios.

European economic developments, including Germany's easing of its debt rules and €1trn spending plan on defence and infrastructure as well as the broader re-industrialisation efforts, are expected to boost growth - and have attracted investor attention. European equity markets’ skew towards value rather than growth, higher dividend yields, and attractive valuations compared to US stocks, have provided additional catalysts. 

Record inflows

Arguably, valuation gaps between markets can remain large and persistent for long periods. It is typically only when underlying fundamentals shift that valuation extremes start to unwind. This is where expectations can play a big part. What really matters for financial market performance is not so much the path of future outcomes, but rather the outcome relative to expectations. Europe and Germany are a good example. Investors came into this year too optimistic about the continuation of the trends in equities that have defined the past decade, while they were too bearish about European prospects.

While earnings growth remains lacklustre in Europe, potential opportunities for diversification exist within a global portfolio. On a sector comparison, European stocks trade on much bigger discounts on a price-to-earnings ratio than they have typically done in the past, suggesting potential value in some areas. This includes both globally positioned companies that can compound growth and returns, as well as in selected value-oriented areas of the market, such as banks, where shareholder returns have been rising.

European and Asian investors have been directing record sums into global equity funds that exclude the US market. In fact, investors put $2.5bn into world ex-US mutual and exchange traded funds between the start of December 2024 and the end of April 2025, according to Morningstar data, marking the highest monthly total on record.⁴

The inflows also mark a reversal after three years of net withdrawals. Global equity funds that exclude US stocks had been out of favour for years, amid a sustained rally on Wall Street for most of the past decade that has attracted foreign investors. Investors pulled a net $2.5bn from these funds between 2022 and 2024. During that period the MSCI World ex-USA index gained just 7%, compared with a 25% rise in the S&P 500.⁴

Emergence of a likely sustained trend

The diversification trend is not limited to equities. There are signs that Asian investors are also diversifying away from the US bond market, driven by divergent monetary and fiscal policies. The interest rate differential between Asian economies and the US has left many investors looking for alternatives. European bond markets are becoming increasingly attractive to investors seeking high-quality alternatives, with less prohibitive hedging costs, due to the narrower interest rate differential to most Asian economies.

Europe’s capital markets are still fragmented and underdeveloped relative to the US, while its companies remain overly reliant on bank funding. That said, European Commission President Ursula von der Leyen has made capital markets integration a key priority in her second term. The Commission’s proposals include reviving securitisation, centralising supervision and facilitating retail investment - alongside concluding years-long negotiations over insolvency laws and completing the banking union.

It's important to note that while the trend towards diversification is emerging, the process is likely to be gradual, as globalisation and supply chains are being rewired. Asia’s current account surplus has remained high, rising to a record US$1.1trn in Q1. US dollar investments are expected to retain their dominance for the foreseeable future and any large-scale shift will take time to unfold.

Looking ahead, Asian investors (and investors more broadly) heavily exposed to US assets are likely to consider Europe and other international opportunities, in a bid to find a path to more balanced, and potentially more resilient portfolios.