Despite this, many investors avoid the asset class. Here, we explain why we think they could be missing out.

Emerging markets (EM), a term coined by Antoine van Agtmael four decades ago, refers to countries in the process of rapid industrialization and economic development. Of course, EMs 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 emerging markets?

Many EMs are in the early stages of their development. This means they have better long-term growth prospects relative to the more mature developed markets (DM). According to Forbes, EMs 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 urbanization, 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. As illustrated in Chart 1, spending patterns will increasingly resemble those seen in middle- and high-income economies with changes in consumption amplified by demographic shifts.

Source: abrdn (March 2023).

Demographic dividend

Most EMs have young and growing populations. By 2025, 90% of the world's working-age population will live in EM countries, 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 programs like education and healthcare.

Source: abrdn, Haver, World Bank (March 2023).

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. As highlighted in Chart 3, EM infrastructure investing is expected to far exceed that of DMs, with a significant investment gap between now and 2040.

Source: Swiss Re Institute estimates, based on data from Global Infrastructure Hub and Oxford Economics.

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.

Bargain hunting

Investing in EMs 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, EMs 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.

Source: Bloomberg, 31 August 2023. For illustrative purposes only.

This risk/reward dynamic also applies to bond markets. Many EM government and corporate bonds offer markedly higher yields than DM equivalents. Again, this represents a buying opportunity for canny investors.

Source: abrdn, Bloomberg, 31 August 2023. MSCI Indices, *MSCI China PE – 12-month forward (rolling), PB – Historic. Monthly data points.

Why now for emerging markets?

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 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.

Final thoughts

With economies growing and their middle classes flourishing, EMs offer a world of investment opportunities. Many leading the way in the technologies of tomorrow. Equity valuations are also attractive. By carefully considering the risks and rewards, investors can capitalize on these dynamic and growing markets.

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