A positive backdrop for emerging market assets

investment viewpoints

A positive backdrop for emerging market assets

April 11, 2019

Didier Rabattu

CIO, Sustainability Equities

Why are emerging markets an attractive investment opportunity?

Loose global monetary policy has helped developed markets recover in the decade since the 2008 financial crisis, and last year’s US tax cut further boosted the economy from the fiscal side. Still, this fiscal stimulus is now fading, and together with an expected (but gradual) reduction of monetary policy accommodation, the developed World could see a slower rate of growth, with 2018’s boost expected to fade in 2019.

Against a backdrop of easy monetary policy and fading US fiscal stimulus, US stock prices appear inflated, while in parallel, Europe’s markets are under pressure with political instability (Brexit, Italian debt, Merkel’s successor).

Investors are therefore searching for value elsewhere. January’s inflows of USD 23.1bn into emerging market funds, investing into ‘cheaper’ equities and positive carry debt positions, confirm this¹. In short, we still see promising opportunities in the Western World, but we also believe the lessening stimuli in those markets may have a knock-on effect, with investors increasing their allocations to the growing prospects that exist in less developed economies.

Will emerging markets continue to grow, and if so, how can investors capture this opportunity?

Globally, we do not see a recession on the horizon, although we do see a more volatile and dynamic environment which investors will have to adapt to. We expect the U.S. may start to underperform global markets in 2019 and the emerging markets to outperform, drawing investors’ attention. We believe developing economies hold some of the best growth prospects and investment opportunity.

In our view, investing in EM should be done in a structured way; by this, we mean a structured allocation of debt, equity and commodities exposure, with an underlying focus on currency. This approach increases diversification and should provide a vehicle that can capture growth and weather cycles.

How have emerging markets evolved throughout recent history?

Emerging market economies have changed fundamentally over the last 30 years and are now more diversified and less volatile. The MSCI Emerging Market index was launched in 1987 and at the time, it contained 10 countries, excluded China, South Korea and India, and equated to around 1% of Global market cap. The main constituents at this time were Malaysia, Brazil and Thailand. 30 years later the index has grown to hold 24 countries and accounts for 12% of Global market cap, with China, South Korea and India making up over half of the index. Today EM economies account for over half of the world on a GDP basis (PPP). Once dominated by commodity exports, EM has now grown to a technology-orientated economy, driving innovation, with broadening opportunities in the domestic sectors serving a growing middle class. As these economies and their access to capital continue to develop, so will the investment opportunities.

Are emerging markets more volatile than developed markets?

The perception that emerging markets are very volatile has been entrenched for many years. EM were more volatile than developed markets from the 1990s up until the last four or five years. However, recently, realised equity market volatility is roughly the same for EM as Europe. Some currencies in emerging markets have been extremely volatile - Argentina and Turkey for example - but the vast majority of currencies, especially the larger ones like the RMB or Korean Won, have been much less volatile than the Euro in recent years. It is therefore important that investors keep this in mind and have a structured approach to currency exposure and hedging.

How important is sustainability?

At Lombard Odier Investment Managers, we believe sustainability will affect every corner of the investable universe, creating the biggest investment opportunity in modern history. We believe megatrends such as demographic change, climate change, natural resources, digitalisation and inequality will continue to disrupt and fundamentally change our economies. Interestingly, emerging markets and especially frontier markets, have shown a ‘leapfrogging’ effect. For example, electricity plays a crucial role in the socio-economic foundations of many developing countries. Without any existing infrastructure, many communities are deploying technology across multiple sectors (e.g. banking), leapfrogging much of the developed world.

The Internet of Things will also continue to provide increasing access to basic services, including education. India is an interesting case, with the government having adopted a digital approach to census data, tax collection, and the distribution of welfare. This has stimulated a wealth of investment into the infrastructure surrounding these technologies, with many manufacturers competing to supply the population of 1.2 billion with equipment at affordable prices.

As a result of these structural changes, we believe emerging markets can present a wealth of sustainable investment opportunities.

source.

¹J.P.Morgan, EM flows, Global EM Research, 31 January 2019.

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