Rising incomes and technological change in the emerging economies present considerable investment opportunities for investors with longer-term horizons.
Investments in emerging markets weren’t spared the impacts of the global coronavirus pandemic. But the ongoing crisis has had uneven effects, with economies and sectors reporting widely-varying results while revealing important lessons for investors in 2021 and beyond.
While emerging markets ended 2020 on a high note, the year was also marked by a significant amount of money exiting the sector, says Philip Erhmann, senior portfolio manager for the emerging markets equity team at Manulife Financial Corp.
“It’s only been since late 2020 that we’ve seen a pickup in flows, which is appropriate given the recovery in economies and leverage and the changing nature of many of the sectors and companies that we’re investing in.”
He says performance in 2021 will be determined by how quickly global economies can drag themselves out of the “very sharp and deep recession” created by the pandemic. According to the International Monetary Fund, the global economy contracted by 4.4 per cent in 2020, the worst decline since the Great Depression. The organization noted China was the only major economy to report growth last year, while the U.S. shrank by 4.3 per cent.
This recovery will be unevenly distributed based on the relative fiscal positions of individual markets, but it could also lead to reforms that make economies even better prepared to weather the next crisis. “The hope is that the few recalcitrant emerging economies that have talked a lot about structural reforms but have failed to enact them may be pressured to do something.”
Asia: poised for growth
Several key Asian economies — namely China, South Korea and Taiwan — were among the first and most heavily-impacted in the early days of the crisis. The novel coronavirus is widely believed to have started in Wuhan, China, in 2019 before spreading around the globe and was ultimately declared a pandemic by the World Health Organization in March 2020. But with a strong and early response, these markets in the East minimized the economic effects of the global pandemic and not only remained open for business but grew their economies as others faltered. Ehrmann says this growth also speaks to strong management of businesses in these economies.
“China’s economy was assumed to be the factory of the world. Not only was it the factory of the world, it was the factory that never shut down. China had it very light and the Chinese economy grew by just over two per cent last year in real terms, whereas most of the rest of the world was trying to avoid double-digit declines.”
Underlying those factors in China is consumer spend by a “young, urban, and tech-friendly” market that seeks recognizable brands to symbolize their social status, says Jin Zhang, a portfolio manager at Vontobel Asset Management. He cites the growth of international brands in the country like brewer Anheuser-Busch Co. and Yum! Brands, Inc., the parent company of fast-food brands such as KFC, Pizza Hut and Taco Bell.
In South Korea’s case, experience dealing with the severe-acute respiratory syndrome outbreak in 2003 that it applied to this public-health crisis proved vital to keeping the economy afloat in 2020, says Nicholas Field, a fund manager at Schroders.
Tech continues to grow
Asia is also home to several of the world’s largest manufacturers of memory chips and semiconductors, products that are in increasingly high demand as the expansion of remote working arrangements and e-commerce accelerated by the pandemic continues to gain steam, Zhang says.
“We’re relying more on our smartphones and a good part of that is memory. A lot of our data is also stored in the cloud, which also needs a lot of memory. It’s a big driver for Korean companies like SK Hynix and Samsung. They’re the number-two and number-one players in memory chips. Samsung has a 50 per cent market share. That’s a very consolidated market.”
He also points to Taiwan, where WIN Semiconductors Corp. not only produces an in-demand electronic component, but weathered the economic fallout through strong management similar to other Asian firms.
“They have very good working relationships with their suppliers and customers. They’re a key supplier of specialized semiconductor chips. They have capacity — and they’re adding capacity. They’ll see another big increase in profits.
“What we’re seeing is the high-quality businesses are adaptive during a difficult time,” Zhang says. “They’ve made changes to the environment and bring good value to their customers. The main thing is they continued to operate and didn’t just sit on their hands.”
How other emerging markets are faring
While Asia’s technology offerings have helped buoy those economies during the pandemic, heavily consumer-based emerging markets such as Brazil and South Africa face a tougher recovery, which Field says will be largely determined by how their respective governments are handling the crisis.
“Time is a factor. Brazil and South Africa can’t say ‘what’s another six months?’ because it gets more costly to fund longer shutdowns. You’ve got two types of markets and recovery will depend on how the pandemic was handled.”
Still, there are opportunities to be found, Zhang says, citing the example of Brazil-based clothing retailer Lojas Renner, which adapted its business model in response to the pandemic and in the process, outsold international brands such as Hennes & Mauritz AB (or H&M) and Zara SA.
“When the pandemic hit, they were in the process of scaling up the online part of the business and the pandemic was an opportunity to accelerate it. They saw their online business explode. Now they’re online and offline is slowly coming back. They’re able to overcome difficult situations and bring value to customers.”
And Ehrmann says that while China will likely have the best year out of the emerging markets, there’s considerable potential in countries like Brazil and India. “Given that they fell sharply and their economies were curtailed and continue to be damaged by the pandemic, it’s hard to predict exactly when things will turn. But there’s been a move toward normalcy. I expect as the year progresses, some of these larger and strongly performing economies will catch the eye [of institutional investors].”
The pandemic has also highlighted the growing importance of environmental, social and governance factors for both investors and economies, with businesses that implement ESG factors being among the most resilient, he says. “[Environmental, social and governance issues] have been accentuated recently with the need to rebalance health care, including how it applies to [artificial intelligence] and simple tools like vaccines and other pharmaceuticals and providing primary health care throughout society. This is very important for markets like China, India and Brazil, which have very large and under-served rural populations.
“The best companies have the whole market paying attention, whether it’s environmental issues or spending money on their employees. Malfeasance, bad behaviour and inefficiency will all affect performance and the cost of capital a company requires to generate their returns.”
The pension perspective
Angela Lin-Reeve, senior portfolio manager of pension investments at the Royal Bank of Canada, says exposure to emerging markets comes from a variety of sources, with the pension’s portfolio managers targeting these markets by individual asset classes rather than on a macro level.
While these managers favour China for equities opportunities, she says fixed-income investments have mainly taken place in Latin America, based on factors such as each country’s growth rate, current account balances and interest rates. “It’s mostly at the country’s government-bond level where they’re getting exposures. These managers have more exposure to Latin American economies, like Mexico and Brazil and Colombia, based on the view that those economies are faster-growing and have a deferential with the U.S. rates.”
Again, each country’s pandemic response and subsequent economic recovery will factor into these investments, with China, Taiwan and South Korea favoured for strong performances in 2021, she says. “Given the amounts of fiscal stimulus going into developed countries versus emerging markets, factors like the increased need for inflation and reflation that will arise from the developed economies will put emerging economies into a better backdrop in terms of their abilities for [gross domestic product] growth and outlook for currency appreciation versus the U.S. dollar, which is forecasted to decrease as a result of the fiscal stimulus.
“I wouldn’t be surprised if more money flowed into emerging markets through these mandates but we haven’t yet seen a huge shift. Maybe later in 2021 we’ll see more of that happen.”
Alain Carrier, senior managing director and head of international at the Canada Pension Plan Investment Board, says emerging markets factor into all of the CPPIB’s investment programs and represent a growing area of focus within its overall investment strategy.
Focusing on a theme of the growing middle class and this consumption in emerging markets, the CPPIB is focusing on emerging-market investment in a number of sectors such as retail, logistics, education, health care, real estate and technology, with growth concentrated in Brazil, China and India, three markets in which the CPPIB maintains offices. With investments in these markets providing diversification benefits, an increased opportunity set and potential for higher risk-adjusted returns, he says the CPPIB plans to increase its emerging markets allocation to one-third of the fund by 2025.
“Economic conditions and resources available in emerging markets are creating a vast new consumer base and new-found prosperity for billions of people. This environment can foster favourable economic and corporate growth.”
Carrier says that while the pandemic brought unprecedented challenges to economies around the world — and volatility to global financial markets — the emerging-market economies in which the CPPIB invests were not only large and diverse enough to mitigate severe financial fallout, but faced the worst of the pandemic at different times.
“Each one is at a different stage of its own crisis and subsequent recovery. These economies are also developing at a different pace from one another. We don’t expect the pandemic to greatly alter the long-term trajectory for growth for emerging market economies.”
He says the pandemic has also provided both new opportunities, as well as the chance for the CPPIB’s various investment programs to recommit to long-term convictions around a number of existing portfolio companies in these markets.
With the uneven rollout of coronavirus vaccines among different countries, the United Nations said global herd immunity — a percentage which is still being determined by the World Health Organization — is unlikely this year. As of mid-March, the U.S. had administered approximately 96 million vaccine doses, according to the U.S. Centers for Disease Control and Prevention, while China had only vaccinated approximately 50 million citizens by mid-February.
Despite this, the IMF predicts global growth in 2021 will be as high as 5.2 per cent and this surge is set to be led by China and India, which the organization forecasts will grow by 8.2 per cent and 8.8 per cent, respectively. “We’re optimistic about an economic recovery taking place throughout the rest of 2021. For us, though, optimistic doesn’t mean we make material changes to our portfolio in the short term, it means we continue to view our long term capital market expectations as being consistent with where we think the global economy is headed.
“Rising incomes and technological change in the emerging economies present considerable investment opportunities for investors with longer-time horizons. As the economic engine shifts increasingly east and south and capital markets develop in tandem, emerging markets are expected to offer returns in excel of the developed world. Overall, we see room for the emerging market economies to continue to develop and play an increasing role in driving global growth.”
Blake Wolfe is an associate editor at Benefits Canada.