A rich and varied opportunity
Antoine van Agtmael coined the term "emerging markets" four decades ago. EM refer to countries that are in the process of rapid industrialisation and economic development. Of course, EM are not a homogenous asset class. Some nations are economic powerhouses, such as India and China. Others, like Indonesia, are smaller by comparison. Each country has its own currency, political structures, and drivers of growth. For example, Brazil and Argentina are major exporters of commodities, while China and India are big importers of raw materials.
Why invest in EM?
Many EM are in the early stages of their development. This means they have better long-term growth prospects relative to the more mature developed markets. According to Forbes, EM account for 80% of the world’s growth – and will continue to drive the global economy in the decades to come.
Growing middle class
Having lagged for decades, EM countries also boast increasingly skilled workforces, operating in areas like technology (e-commerce, microchips, smartphones, artificial intelligence (AI) and 5G), finance and the ‘green’ transition.
This, added to broader economic growth and mass urbanisation, is leading to a burgeoning EM middle class. The Brookings Institution estimates that by 2030, two-thirds of the global middle class will reside in emerging economies.
As a result, we’re seeing a shift in consumption patterns and lifestyle aspirations. This growing consumer base is leading to higher demand for a broad range of goods and services. Notably, high-end sectors like luxury goods, healthcare and travel.
Most EM have young and growing populations. By 2025, 90% of the world's working-age population will live in EM, according to the United Nations.
A younger population typically means a larger workforce, higher productivity, and increased consumer spending. It also means more taxes to pay for social programmes like education and healthcare.
Building the future
EM nations are often upgrading and expanding their infrastructure to accommodate growing populations. This includes investment in transportation, energy, water, and telecommunications systems. The numbers are huge. The Global Infrastructure Hub states that emerging economies will require approximately $97 trillion in infrastructure investments by 2040. This spending presents opportunities for investors in sectors such as construction, materials, engineering, and utilities.
Diversification benefits for investors
When it comes to investing, you don’t want to put all your eggs in one basket. Different asset classes often behave differently. Investing solely in developed market equities will expose investors to the risks and fluctuations specific to those markets. By including EM equities in portfolios, investors can reduce risk by spreading their investments across different regions and sectors. This potentially creates a more balanced and resilient portfolio.
Investing in EM isn’t without risk. Countries are often buffeted by political instability, regulatory upheaval, poor governance, and currency fluctuations. However, this elevated risk is often reflected in a company’s share price. Many excellent businesses are therefore undervalued relative to their potential. Compounding this inefficiency, EM are less well covered by sell-side analysts. For example, there are as many as 103 companies in the index with only one analyst. Savvy investors, who are willing to do their homework, can pick up gems at bargain prices.
This risk/reward dynamic also applies to bond markets. Many EM government and corporate bonds offer markedly higher yields than developed-market equivalents. Again, this represents a buying opportunity for canny investors.
Why now for EM?
The world is a volatile place in 2023. Inflation and interest rates remain high, while geopolitical risks continue to mount. That said, EM countries were ahead of the curve on inflation, increasing interest rates before their developed peers. China, Brazil and Chile have already cut rates this year, with other countries like Mexico looking poised to follow. This makes them a relatively attractive destination for overseas investors, particularly in bonds.
Another factor to highlight is nearshoring or onshoring. In the wake of Covid-19 and mounting China-US tensions, companies have reconfigured their supply chains. Many have brought them closer to home, ensuring stability and resilience. As a result, opportunities abound for companies in certain industries and countries, such as Indonesia and Mexico.
The rapid adoption of AI has widespread benefits for EM. They are home to many of the world’s leading manufacturers of microchips and/or components to make associated parts. These chips are crucial in the development of AI platforms. With spending on AI already astronomical and set to rise, EM should continue to prosper.
And then there’s the energy transition. Most materials needed for ‘green’ technologies are produced in EM. Demand for these will only grow as the world moves to net zero. China is already the world’s largest manufacturer of batteries, wind turbines, electric vehicles, and solar panels.
Speaking of China. Many expected the country to take-off once it exited stringent lockdowns in 2022. Since then, however, concerns about the economy and property sector have weighed on consumer spending and activity.
Nonetheless, a spending revival is underway. Trading conditions for companies have also improved, which should eventually spur job creation and better wages. Add measures to tackle debt in the troubled property sector and targeted policies to support wider growth, and we believe the long-term opportunities in China remains intact.
EM offer a world of investment opportunities. Economies are growing and their middle classes are flourishing. Many lead the way in the technologies of tomorrow. Equity valuations are also attractive. So, by carefully considering the risks and rewards, investors can capitalise on these dynamic and growing markets.