Rising US interest rates and a strong Dollar have typically been an inauspicious backdrop for emerging markets. However, they have shown surprising resilience amid a tough year. It may signal a new vigour within the sector; investors should take note.

Viktor Szabo, manager on the abrdn Latin American Income Fund says: “There has been a huge global inflationary shock, the war in Ukraine and its consequences, plus the Fed has raised interest rates quite aggressively. We had all the ingredients for quite shaky markets. There have been sell-offs across fixed income and equities, but when we look at the performance of economies and companies, there is definitely resilience.”

The reasons for this resilience are unique to each country, but there are some patterns that can be drawn. There are shorter-term reasons: Latin America and Indonesia have been beneficiaries of rising commodities prices, for example, while India is benefiting from its robust recovery from the Covid crisis. Many Asian economies stuck with lockdowns for longer and are therefore at an earlier stage in their recovery process.

However, there are also structural reasons for emerging market resilience that may prove more important in the long-term. Viktor says: “Emerging markets have improved their sovereign balance sheets and, in many cases, are running surpluses. Policy making has also improved and here I would highlight the independence of central banks. It has brought them real stability.” He points out that emerging market central banks started their tightening cycle well before many developed markets and, as a result, may now be closer to the end.

Stable politics are an increasing feature of emerging markets, in notable contrast to some developed markets over the past 12 months. The contrast is perhaps most evident in Latin America, which has swung left in recent elections, but has not succumbed to the fiscal excesses of previous leftist governments. India has also benefited from a reformist government that has strengthened institutions and infrastructure.

China weakness

China has been the notable exception in a generally strong picture for emerging markets. Elizabeth Kwik, manager on the abrdn China Investment Company, says there have been two main concerns: how long the government will stick to its zero Covid policy and the implications of over-leverage in the real estate market.

Nevertheless, she believes the picture is improving, particularly after the recent protests showed the extent of public dissatisfaction with the policy: “Even though the government is nominally sticking with its dynamic zero Covid policy, there have been signs of easing. Lockdowns are not as lengthy or stringent as we saw at the beginning of the pandemic. More international flights are running. There is a desire to reopen the economy, they are just trying to do it in a way that balances the needs of their citizens.”

Stockpicking

Nevertheless, in spite of their relative resilience, emerging markets cannot be immune to the weakness in the global economy. Samantha Fitzpatrick, investment director on Murray International, says: “It is a good time to be a stockpicker in emerging markets. Having the flexibility to move around the regions is vital.”

She says that the gap between sentiment and operational performance for many emerging market companies is creating opportunities. Even in the unloved Chinese property cycle, there will be winners and losers. “Reckless, overleveraged companies are being wound down in a managed way, and other companies will need to come in. It is in no one’s interest to have building sites sitting half finished.

Semiconductor companies have also been out of favour, hit by supply chain weakness, but, she adds, “There are world-class companies in emerging markets. We have no doubt they’ll be around for years to come. Even through the doom and gloom of the global economy, certain pockets are seeing phenomenal growth.” Murray International also holds a Chilean lithium company, which is supplying electric vehicle manufacturers, plus a Mexican airport operator, which had a torrid time during the pandemic, but has recovered strongly.

In China, Elizabeth is focusing on the highest quality companies, which should be in a position to withstand domestic and external pressures: “We’ve identified five key investment themes for the trust that we believe are aligned with the government’s strategic direction and where there are opportunities for long-term growth. For example, one theme is aspiration: We believe populations will continue to get more affluent and upgrade their standards of living.”

The team is also looking at green initiatives and digital initiatives. She says: “The government wants to be carbon neutral by the year 2060. It also wants to be self-sufficient in sensitive sectors within technology and is therefore trying to build up home-grown intellectual property. That plays to themes such as cyber security.”

Latin America is also a green pioneer and not just at a company level, but also at a sovereign level. Chile is the lead issuer of labelled bonds in emerging markets and has launched the first sovereign sustainability-linked bond in the world this year, while Mexico and Peru have issued sustainability (combining green and social) bonds and Colombia has issued green bonds.

The biggest risks for emerging markets largely lie outside their control. It is still possible that developed market central banks will not win the war against inflation, for example, and be forced to tighten policy further. This would hurt emerging markets. Emerging market banks may have done their homework, but it is also up to developed market central banks to bring down inflation and put their economies on a sustainable path. For China, there is also a significant risk of rising tensions between the US and China.

Nevertheless, Samantha believes emerging markets are a very different prospect to a decade ago: “People have been quite judgemental about emerging markets, but we see more instability elsewhere.” Emerging markets are home to some compelling long-term opportunities, often overlooked by investors.

Important information:

Risk factors you should consider prior to investing:

• The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
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• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
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• The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.

Other important information:

Issued by abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Authorised and regulated by the Financial Conduct Authority in the UK.

Find out more by at:

www.murray-intl.co.uk

www.abrdnchina.co.uk

www.latamincome.co.uk

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