Which emerging markets should investors be considering?

When analyzing the likelihood of a trade war means keeping one eye on Twitter, the global backdrop for risk becomes more troubling.

“You definitely start by taking that global temperature — looking at growth, inflation, interest rates, commodity prices, currencies, event risk,” says Rob Hall, institutional portfolio manager on the emerging markets debt team at MFS Investment Management.

On May 5, 2019, with two tweets threatening further tariffs on Chinese imports, U.S. President Donald Trump sent markets skidding downwards. “As you might imagine, since those tweets emanated from the White House, we’ve been thinking a lot about how the global risk landscape has changed,” says Hall.

Read: Are tensions between China and the U.S at trade war level yet?

And this tense atmosphere affects whether institutional investors have room for the accompanying risk of allocating to frontier and emerging economies. “Smaller countries, in our investible universe, are often higher risk countries, so it can impact how you think about investing in those countries if your general read on global risk is that conditions have deteriorated,” he says.

In an environment chock-full of uncertainty for developed markets, asset managers expect to see outperformance in emerging market equity in the near term, says Jean Bergeron, vice-president and managing partner of Morneau Shepell Ltd.’s asset management practice.

These days, pensions plans are far more likely to be exposed to these markets. “The trend we’ve seen in recent years is a reduction in exposure to Canadian equity and an increase in allocation to foreign equity, especially to emerging markets,” says Bergeron. “Ten years ago, we didn’t have any plans that had emerging markets, but in the last five or six years there is much more interest. And we systematically recommend to our clients to have some kind of allocation to emerging markets within their equity portfolio.”

So as global markets continue to churn, which emerging markets are offering growth opportunities for institutional investors?

Breaking from the benchmark

The more oft-discussed emerging markets, such as Brazil, Mexico, Russia and South Korea, have been swelling at a rapid clip, making them attractive to investors looking for growth exposure, says David Dali, portfolio strategist at Matthews Asia.

However, those markets just can’t keep up that velocity. “These large developed countries that were growing at five and six per cent per annum, up until 2011, are now growing at two per cent per annum,” he says. “So if you’re an investor and you’re looking for growth, what are you left with? You’re left with, hopefully, going to some of the lesser-known, smaller, but fast-growing economies. The problem is . . . the emerging markets benchmark doesn’t have any of these fast-growing economies within the benchmark.”

Read: What’s the investment outlook for pension funds in 2019?

Within emerging market indexes, Dali calls Bangladesh, Indonesia, Pakistan, the Philippines, Sri Lanka and Vietnam some of the most dynamic economies, yet their presences are minuscule. “Some of the fastest growing countries in our investible universe are not represented [in the benchmarks] at all.”


However, the custodians of these benchmarks play a role in helping emerging markets grow on the world stage, says Joti Rana, head of governance and policy for the Americas at FTSE Russell.

Argentina is currently on FTSE’s watch list for a potential upgrade from a frontier to a secondary emerging market, he says. “We’re working hand in hand with both the exchanges and the domestic authorities.”

But politics can play a huge part in whether the developments required for an upgrade actually happen. “One thing that we’re cognizant of is, you’ve got the elections coming up this year so we are watchful as to what we announce around that period,” says Rana. “It might be the case that we wait to see how the election goes before we do anything with Argentina.”

Institutional investors’ feelings on a given market are also paramount, he adds. “If our clients are comfortable that Argentina is investible — basically that they can get their money in, while it’s in the market it stays there and then, if they want to, they can get it out, without any controls — then we’re happy to proceed with adding Argentina.”


When looking at a specific asset class, determining appropriate risk levels for emerging market debt is a complex process, says Hall. Before choosing an emerging market, institutional investors should first have a good grasp of sovereign bonds in order to understand the variety of debt instruments.

“Our view has always been that if you don’t get the sovereign part of the equation right, you’re probably not going to get the corporate part right either.”

Read: How is fixed income faring amid renewed market volatility?

To a certain extent, any risk that’s priced into the sovereign side of the bond market is also baked into the corporate side, he adds. In seeking opportunity in emerging markets, countries with less risky — and therefore more expensive — sovereign debt could present a favourable chance to take on corporate bonds.

“Chile is a classic example of that, where the sovereign spreads are really pretty tight, pretty expensive,” says Hall. “So there are some good opportunities in the corporate space and we’re not shy about investing in those.”

Taking on Chilean corporate debt means investing in a sector spread fairly similar to Canada’s, since it features financials, energy, metals, mining and utilities.

In the past decade, many of Canada’s largest pension funds have invested in Chile. Back in 2011, the Ontario Teachers’ Pension Plan increased its existing stake in two Chilean water utilities. In 2017, The Ontario Municipal Employees Retirement System took a 35 per cent stake in a liquified natural gas provider. Both the Alberta Investment Management Corp. and the Canada Pension Plan Investment Board have invested more than $1 billion in deals involving Chilean toll roads. And most recently, the Caisse de dépôt et placement du Québec took a 45 per cent stake in DP World Chile, which operates two of the country’s major ports.

What’s the difference between a frontier and an emerging market?

Different index providers develop their own criteria in order to designate a particular market’s qualification, rather than going by a single set of rules.

However, frontier markets typically have less developed capital markets, with less activity going on. As a result, these markets are usually less liquid and, often, their working populations earn less per capita than in an emerging market.

In addition to measuring whether securities are large enough and liquid enough to contribute to a country’s status, MSCI Inc. specifically uses five criteria to determine market accessibility:

  • Openness to foreign ownership;
  • Ease of capital inflows/outflows;
  • Efficiency of operational framework;
  • Availability of investment; and
  • Stability of the institutional framework.


Technically classified as a non-self governing territory by the United Nations, Bermuda consists of several islands that make up just under 54 square kilometres. Under the administration of the U.K. since 1946, this tiny landmass still has an economy worthy of investor attention, according to Talbot Babineau, president and chief executive officer at IBV Capital Ltd.

But in order for his firm to invest in such a small economy, it had to build its expertise from the ground up. “Initially, I made a successful investment in a Cayman Islands electric utility. . . . So through that I grew a bit of a core competency in determining what a presumably well-run electric utility, in an isolated environment, would do from an economic standpoint and what a regulatory environment would look like there.”

Read: How are trade jitters, geopolitical risk affecting equities?

Babineau’s firm hit upon Ascendant Group Ltd. as a potential investment. Listed on the Bermuda Stock Exchange, the equity was extremely illiquid. “Once we started peeling back what the company did, we realized that it had a couple of odds and ends businesses . . . and core to its assets was the Bermuda Electric Light Co.”

In order for the firm to gain the confidence to build a position in the investment, it hired a local legal team to fully understand the regulatory environment for utilities in the region. That led to meeting with the territory’s minister of economic development about his vision for how regulations would develop going forward.

With all this analysis, the company showed major potential for improvement, says Babineau, with the endgame to either re-list the company on a more established stock exchange or to sell it outright. The firm started buying shares at around $5 and eventually build a 10 per cent stake in the company. Early in 2019, the company was put up for sale and, in June, Algonquin Power & Utilities Corp., a Canadian energy company, agreed to buy it for US$36 per share.

“It’s hardened our resolve to go and find interesting opportunities in jurisdictions that maybe people don’t entirely appreciate.”


Kuwait is another country on the cusp of an upgrade, moving from consideration as a frontier market to an emerging one. It was reclassified by FTSE Russell in September 2018 and has been added to the MSCI Inc.’s watch list.

“Should Kuwait be included in the MSCI index, we expect more than US$2 billion in passive flows into the country, with the increase in liquidity supporting market performance,” said Chetan Sehgal, senior managing director, emerging markets equity at Franklin Templeton, in an email to Benefits Canada.

Read: Number of indexes on the rise, led by fixed income: report

The country has also been working on reforming its capital markets and improving corporate governance standards. “The sovereign is AA rated, supported by ample reserves and low debt levels, providing a cushion as the government focuses on diversifying its economy and reducing its dependence on oil, while reforming expenditure and the job market,” says Sehgal.

“The government has also set ambitious 2035 targets involving heavy infrastructure spending and a focus on education and health care, while improving transparency and efficiency in the government.”

Waiting, hoping, wishing

FTSE Russell periodically releases a list of countries in flux, demonstrating significant progress or reaching notable milestones in their growth journeys. It establishes a market’s classification based on a number of criteria with bearing on how and whether foreign investors can do business there.

Argentina — potentially moving from frontier to secondary emerging market. While the country has improved on multiple fronts, including the beginnings of a derivatives market, the liquidity levels of the Buenos Aires Stock Exchange are still holding the market back.

Romania — potentially moving from frontier to secondary emerging market. While it’s been on the watch list for this shift since 2016, liquidity in the country’s stock exchange remains restricted.

Tanzania — potentially becoming a frontier market. While it currently meets five of the required criteria to be classified as frontier, countries must remain on the watch list for at least a year for valuation purposes.

Vietnam — potentially moving from frontier to secondary emerging market. While it’s improving on a number of fronts, the country no longer meets the criteria permitting off-exchange transactions.

Source: FTSE Russell, March 2019


Vietnam could be the next, great Asian success story, says Dali, noting his firm spends a lot of time looking at which sectors could grow the fastest and which companies could benefit the most from population development. “Vietnam is an extremely fast-growing country whose population is becoming rich very quickly.”

On average, Vietnamese salaries have tripled in the past decade, he adds, and this means domestically oriented sectors are doing big business. One challenge is that the country’s stock market is at an earlier stage in its development, so investors looking at the region are hampered by that limitation. However, a decade ago, Vietnam offered about 100 stocks that Dali’s firm considered to be investible, and that’s multiplied to around 1,400 today.

Read: Which frontier markets are institutional investors exploring?


Canadian defined benefit plans hold $74.97 billion in emerging market equities, totalling 3.56% of assets. Meanwhile, Canadian defined contribution plans hold $190.67 million, totalling 0.79% of assets.

Source: Willis Towers Watson, 2018

“It’s really quite an exciting place,” he says. “And all we’re waiting for as an international investor is for that stock market to develop even further. What we’re finding [is], a lot of these great opportunities within these countries are limited. So we’re a little bit captive to the indigenous growth of those stock markets.”

Institutional investors shouldn’t make the mistake of thinking of Vietnam as small simply because it sits in the shadow of its neighbour China, says Ian Beattie, chief investment officer at NS Partners Ltd. “It’s quite a big stock market now. Valuations are OK. They’re not cheap anymore. It’s a big country.”

In addition to the swell of its equity market, the country’s demographics make it very investable. Within a population of about 94 million people, 55 million are working age, with an average overall age of 31. And with excellent language and labour skills, as well as largely amicable trade relations in a world where that’s less and less the case, Vietnam is primed to jump forward, says Beattie.

“This is one that I could see being an emerging market rather than a frontier market in the next few years.”

Martha Porado is an associate editor at Benefits Canada.