Emerging markets have never really been a wallflower in the world of capital market news. Even with this said, however, the past three years have been fairly extreme in terms of the range of events that have played out in the asset class, and the persistent and overwhelming levels of news flow this has created. The resulting uncertainty, against an increasingly challenging global backdrop, has led many investors to ask: have emerging markets lost their mojo?
The only constant is change
Developing economies account for over 85% of the global population, 45% of global GDP [1], and 11% of the MSCI World index [2]. Historically, returns and growth have been superior to more developed nations, driven by the global competitiveness of these economies to produce certain low-cost goods, services and resources. As a consequence, the development of emerging economies has lifted millions out of poverty and in many instances enabledcompanies in these countries to shift up the value chain, providing increasingly complex products and services.
The primary drivers of long-term returns have always been different across emerging markets: oil in Russia; infrastructure in India; consumption in China. Over the past three years, news flow has also highlighted a number of short-term differences which have, in many instances, badly hurt investor confidence: China’s trade tensions; Turkish geopolitics; US Russian sanctions; extreme right-wing politics in Brazil; a swing to the left for Mexico – many markets have traded headline to headline, with investor uncertainty high.
This feature of the market has been dramatized further by the equity market response to COVID 19. The majority of emerging markets have not been immune to the awful human and economic cost of the global pandemic. However, of the top 10 countries ranked by deaths per capita, not one is an emerging nation, and already in geographies such as mainland China, Taiwan and South Korea there is a gradual semblance of normalisation in economic activity. Despite this, with the very noticeable exception of China, many of the worst performing major equity markets year-to-date are emerging markets.
Structural development, bottom-up opportunities
While many associate emerging market investment with large factories churning out low cost goods, the opportunity for equity investors goes far beyond manufacturing – indeed ‘industrials’ is one of the smallest sectors in the index. Persistent trends providing opportunities for companies in these markets include financial inclusion, healthcare penetration, infrastructure development, rising consumption, and technological innovation. These changing thematics are, for many firms, the dominant driver of long-term returns, far more so than the policy-driven and cyclical events that drive the news cycle. Indeed, there are many company-level examples showing that fundamental corporate growth in these markets has remained strong, a fact often lost in the noise.
Company-level opportunities benefiting from long-term structural change include IDC, a diagnostic firm in Egypt prospering from greater healthcare spend, Netease, a leading Chinese game developer, proving highly effective competing overseas; Purcari, a Moldovan wine producer, thriving as disposable incomes rise and consumption trends change in eastern Europe, and Salmones Camanchaca, a Chilean salmon farm operator prospering from greater fish based protein consumption in Asia plus north America. Beyond emerging markets, frontier opportunities can promise even greater structural growth; for instance Kenya Commercial Bank, the economy’s largest bank, operating in an country of over 50 million people with fewer than 30 thousand mortgages [3]; or Vietnam dairy, positioned to benefit as per capita consumption of dairy products rises from a very low base. None of these businesses is immune during periods of macro weakness, but all have demonstrated multi-year growth over-time, are resilient and remain well-positioned to benefit from change in their respective markets.
Looking beyond the chaos
There is a huge range of possible outcomes for what the shape of the next twelve months will look like, and the simple truth is that it is too early to tell with real confidence. What we do know however, is that valuations for many emerging market companies are currently low – in absolute terms against their history, but also noticeably so against many developed market peers. This was already the case prior to the pandemic, and this has only been only been exacerbated by the further exodus of foreign capital from these equity markets. Emerging markets will always be to some degree more ‘noisy’ than developed markets; not every good company will be a good investment and there remains a real range of risks in addition to the structural opportunities. However, many companies in these markets have resilient business models and balance sheets coupled with low valuations and attractive outlook driven by structural change, and it is this side of the equation that we believe has been overlooked in recent years.
