Emerging markets: investors’ double-edged sword?

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.