Emerging markets offer diverse opportunities

Emerging markets can vary widely in size, with the stocks of six markets — China, South Korea, Taiwan, India, Brazil and South Africa — currently accounting for more than 75% of the weighting of the MSCI emerging markets index.

“Emerging markets represent one asset class that will continue to grow, that will not go backward,” says Matthew Strauss, vice president and portfolio manager with CI Investments Inc. in Toronto. As the economies of emerging markets continue to mature while their financial services sectors grow, they will create an increasing number of investment opportunities.

One of the key drivers of emerging markets is their rate of economic growth, which is much faster than that of developed markets. The International Monetary Fund estimates that the gross domestic product (GDP) of emerging markets for 2018 will grow at double the pace of developed markets: 4.9% for emerging markets vs 2.5% for developed markets. That gap is expected to widen, with estimated GDP growth of 5.1% in emerging market vs 1.7% in developed markets in 2020.

Emerging markets, as a result of their higher growth rate, account for 75% of global GDP growth, says Christine Tan, associate vice president and portfolio manager with Sun Life Global Investments (Canada) Inc. in Toronto.

Chetan Sehgal, senior managing director of Franklin Templeton Emerging Markets Equity in Singapore, a division of Franklin Templeton Investments Corp., suggests that emerging markets are benefiting from several factors, including “a supportive global macro backdrop, improving economic fundamentals, ongoing reforms, a favorable earnings outlook and attractive valuations.”

Emerging markets also are “better managed than in the past,” and the risk traditionally associated with investing in them has declined, says Arup Datta, senior vice president and head of Mackenzie Investments’ global quantitative equity team in Boston. Although emerging markets still areperceived as risky, he adds, that perceived risk is typically associated with higher long-term returns.

“The structural case for emerging markets continues to center on demographics, a rising middle class, domestic consumption and the growing adoption of technology,” Datta says.

Many countries also have benefited from “reformist, business-friendly governments that seek to reduce bureaucratic barriers to economic growth and encourage entrepreneurship,” he adds.

Tan points out that many emerging market countries have a rising middle class and a younger demographic, which can have a positive effect on their economies in the form of higher incomes, increased consumer spending and accelerated infrastructure development.

Sehgal adds that businesses in emerging markets are improving, as well.

“Emerging markets companies have undergone a significant transformation,” Sehgal says, “from the often plain-vanilla business models of the past, to a new generation of innovative companies that are moving into technology and higher value-added goods and services.”

Tan and Datta note that emerging markets are not a homogeneous asset class, and they are at various stages of development. “It would be a mistake to lump all emerging markets into a single asset class,” Datta says. “Some are mature, and some are early-stage.”

For example, Tan says, India has a relatively young population, which has contributed to strong growth in consumption. China, on the other hand, has an aging population that has resulted in higher consumer spending in areas such as health care and travel.

Strauss advises that when investing in emerging markets, you have to consider the region, the country and the sector. For example, Latin American markets and South Africa are endowed with natural resources and are most vulnerable to a decline in commodities prices.

Strauss notes that changes in commodities prices can affect different emerging markets in different ways. “Lower oil prices, for example, are bad for producers,” he says. “Higher prices are bad for net importers such as Turkey and India.”

But, Strauss adds, commodities are no longer a core theme when looking at emerging markets

Countries such as India and China, which are more reliant on exports, can be affected by a global downturn and by issues such as trade protectionism, which has reared its head under the Donald Trump administration in the U.S.

But most emerging-markets companies now also have a domestic component to their growth, Strauss says, and are becoming less reliant on exports.

Although commodities production and exports remain important to certain emerging-market economies, Strauss says, emerging markets have been shifting toward “new economy” industries, underpinned by innovation and consumption.

“Many investors continue to view commodities as the dominant driver of emerging markets,” Strauss says, “but we consider this a misperception.”

This is the first in a four-part series on investing in emerging markets.