A look at the impact of coronavirus on the structural case for emerging markets

Historically, the structural case for investing in emerging markets was centred around the idea of convergence — that over time, relatively poor countries will grow their economies and the corporate base in those countries can take advantage of superior returns, said Nicholas Field, emerging markets strategist and fund manager at Schroders, when speaking at the Canadian Investment Review’s 2020 Global Investment Conference in September.

Emerging markets’ share of global gross domestic product has grown from about 25 per cent in 1980 to nearly 45 per cent today. But the convergence experience hasn’t been the same for all emerging markets.

A country can’t just grow from nothing; growth happens in stages, Field noted. “The usual pattern is that you start off with a cheaper workforce and you use that to develop an export base. And then you use the money from the exports to invest and build up a capital base. And it’s that capital base growing, which gives you that superior growth.”

A factor that investors can pay attention to is urbanization. But when looking at emerging markets’ GDP per capita and urbanization levels, it’s clear many countries still have plenty of runway for convergence, Field noted.

Several factors can drive success for an emerging market: having a young population that is aging, consumes a lot and can be used for labour; the ability of a country to use labour effectively; infrastructure; policy and government stability; rule of law; and property rights. “There are a lot of factors that you need. And you don’t need all of them to be perfect, but you need quite a few of them.”

But there are no guarantees a country will be able to converge, because globalizing is stalling and tensions between the U.S. and China are rising, Field said, noting China is supplying the world with a huge amount of manufactured goods, so the value of manufacturing is dropping and other countries may not be able to see export booms big enough to employ lots of people. “This is part of the reason why you’re getting the tension between not just U.S. and China, that’s the strong bit, but also China and other places.”

The coronavirus is changing the long-term outlook for emerging markets because it is leaving countries with much more debt in both the developed and developing world. And it’s impacting poorer countries more because they have less ability to cushion the blow. “It’s very difficult to say exactly how things are going to pan out, but it does seem that both within the emerging markets country to country and within individual countries, . . . the poorer you are, perhaps the longer lasting the effect is going to be.”

The makeup of the emerging markets index is also changing, with countries like China rising in significance, while other countries, like those in Latin America and Eastern Europe, have become less significant. Further, the composition of the types of companies within the index is changing, he added.

“But what does this all mean in terms of what you’re actually looking at for investing now? You’re not just investing in a bunch of poor countries, which could grow a lot. You may get some of that. But you’re also investing in a much more, in a sense, diverse group of countries than you had available 20 years ago, representing a more diverse set of sectors, representing a new economy and old economy and representing an increasingly large part of the world.”