Emerging markets: investors’ double-edged sword?
From the commodity-based prizes awaiting Brazil and Russia as the world reawakens, to India’s growth as a manufacturing hub, the emerging economies present investors with multiple dynamics to navigate
The term “emerging market” was coined in 1981 by Antoine van Agtmael of the International Finance Corporation, almost as an afterthought.
His team was launching a product tracking ten local stock markets – Argentina, Brazil, Chile, Greece, India, Jordan, Korea, Mexico, Thailand and Zimbabwe – when an investment banker from J.P. Morgan warned their planned label, Third World Equity Fund, might meet resistance. Van Agtmael agreed. After a weekend pondering alternative options, the new moniker was born.
Definitions are far from fixed. Finance company MSCI defines 27 countries as emerging markets, while at FTSE Russell it is 19 and the International Monetary Fund names 23 nations. Countries will also be promoted or relegated from year to year in line with economic progress.
The coronavirus pandemic hit the planet with the most indiscriminate crisis since the Second World War. Yet on face value, you could be forgiven for comparing the performance of emerging and major developed markets, and seeing the former as having had a better 2020, relatively speaking.
The MSCI Emerging Markets Index gained 18.31 per cent in 2020, against the MSCI World Index’s 15.9 per cent, outperforming it for the first time since 2017.
While corporate governance remains a concern, T. Rowe Price investment specialist for capital markets Ritu Vohora sees huge progress.
Most emerging markets are putting in place regulation and codes of conduct to raise and maintain standards. As responsible investing continues its exponential rise, even state-owned enterprises, common across emerging markets, are being held increasingly accountable.
Vohora sees China, for example, putting concerted efforts into its shareholder agenda, prioritising carbon neutrality and raising its transparency game, which are essential to truly compete on a global stage.
Turning point for emerging markets
There are several reasons for optimism, according to Tom Stevenson, investment director at Fidelity. As the world releases from lockdown and international trade and travel resume, exporters and commodity producers will be key beneficiaries.
In emerging market exports, China leads, but Stevenson also names South Korea and Taiwan as well placed to profit from the general economic uptick.
The other major theme on the horizon is the hotly tipped commodity supercycle, which is an extended period demonstrating above-trend price movements, a concept only seen a handful of times in the past 100 years.
Stevenson draws a parallel between the massive fiscal stimulus imparted by the US government with previous supercycles. In the 1960s, President Lyndon Johnson’s ‘war on poverty’ saw a widespread social welfare programme, directing money at low-income households. A similar approach is taking place today, given US president Joe Biden’s $1.9-trillion stimulus programme.
“When you give money to people that haven’t got much, they will buy stuff. Material goods, fridges, cars: all very commodity intensive. That drove the commodity boom in the 1970s. We saw the same thing in China in the early-2000s, with the big rise of the middle class there, and we may be about to see something similar,” says Stevenson.
Brazil and Russia might lead commodity production, but the opportunity maps across Latin America, with fourth-quarter 2020 export prices more than double those posted globally.
Shift to value
The commodity story feeds into a broader trend behind the expected rotation towards emerging markets: the move from growth to value already being witnessed.
Early-stage economic recoveries tend to see value-biased, cyclical sectors perform well. Vohora flags Latin American commodities and the big Russian energy names, while financials, such as Russia’s SberBank, will also be clear winners.
“The main point is, when we talk about emerging markets, we’re talking 80 per cent about Asia. It is no longer driven by Brazil like it used to be,” she says.
While China may be the jewel in the emerging market crown, countries like Vietnam could be seen as the rough diamonds as Western companies look to diversify supply chains away from China, due to trade wars but also the pandemic.
Many emerging Asian exporting countries have seen global supply chains disrupted, but those reliant on hospitality – Malaysia, Philippines and Thailand – could enjoy a rebound following vaccination rollout and a more settled travel outlook, says Teodor Dilov, funds analyst at investment platform Interactive Investor.
Vietnam has been on the “subs bench” since 2018. Technically still a frontier market, the country fell short of FTSE’s emerging criteria once again in 2020, yet still features heavily among emerging market portfolios whose managers have a more forward-looking eye.
Jorry Nøddekær, who leads Polar Capital’s emerging markets growth franchise, has tracked these regions for more than 20 years. He sees Vietnam as among the most exciting risk-return trade-offs, with a strong demographic profile and urbanisation drive helping its bid as a more cost-effective manufacturing hub than China.
One feature of Vietnam, setting it apart from its peers, is its focus on education. “With a strong bias towards natural sciences, their education level is higher than many other emerging Asian countries. I’m not saying they will become the new Taiwan or Korea overnight, but they appear to be on a different path to the likes of Indonesia or the Philippines, for example,” he says.
Superpower of the future
While India has suffered badly from COVID, the nation’s role as a manufacturing hub continues to increase, finally offering Indian people alternatives beyond the niche of IT engineering at one extreme and agriculture at the other.
But with this comes pressure on prime minister Narendra Modi to create jobs or India’s demographic profile will remain a huge untapped resource that could then become a liability.
“That’s the potential Black Swan event: to literally have a lot of young, angry men without jobs, which could be a future risk for social unrest,” says Nøddekær.