While recent market events have shaken investors around the world, those with the confidence to look to emerging markets while bracing through market fluctuations may be rewarded in the long term. In fact, the investment outlook for emerging market equities remains positive, and certain sectors and industries stand to benefit from current market dynamics, including financials, commodities and green energy companies.
Today’s market volatility – driven by inflation, COVID-19 management, the Ukraine-Russia crisis, and bottlenecks in global supply chains – has been challenging for all investors. And while investors will likely see challenges in the short term, our team believes that investing in companies in emerging markets with strong ESG credentials and high quality, sustainable growth will yield results over the long run.
Emerging market equities are trading at all-time lows relative to developed market equities. In addition, in 2022, we are seeing a pivot from growth toward value stocks. Specifically, lower valuation, cyclical companies are benefitting from the change in investor sentiment, and the broad equity market downturn is pushing emerging market valuations even lower. We expect some sectors and industries to benefit from the current macro environment while others will likely be challenged further.
Sectors Expected to Benefit
Financials
Financials stand to benefit from the current market backdrop of higher interest rates in the United States and emerging market economies. Year-to-date, financials are one of the strongest performing sectors in the MSCI Emerging Markets Index.
One factor that influences financials performance in emerging markets is that many of these economies remain heavily cash based, providing a unique opportunity for productivity improvement in financial services. Digitization can help provide financial services to underpenetrated areas, reducing costs and promoting greater financial inclusion across regions. Further, financial inclusion is recognized as vital for economic growth and social welfare and is one of the UN Sustainable Development Goals.
ICICI Bank, a leading private bank in India, offers a wide range of banking products and financial services for both corporate and retail customers and is worth investor consideration. We believe this bank primed to access not only the large unbanked population in India but also retain a competitive market share relative to its capital-constrained or poorly run peers.
AIA Group, a Hong Kong-headquartered insurance and financial services company, is another interesting investment opportunity in this space. As we expect rising penetration of insurance services across emerging markets, we this as amongst the highest growth opportunities available to investors. Increasing financial inclusion across emerging markets can be an attractive investment opportunity while also enabling positive social change.
Commodity-producers and green energy companies
The Russia-Ukraine crisis accelerated many regions’ plans to decarbonize their economy and shift away from the use of fossil fuels. This crisis has also shown that equity markets in commodity-rich or commodity-producing countries can experience broad-based strength over the short term. Further, emerging market companies are located at the heart of global supply chains and positioned to provide many of the solutions required to combat climate change, presenting a key long-term investment opportunity.
Given this backdrop, we see opportunities in both energy and mining companies. One company to highlight is Cosan, a Brazilian producer of bioethanol, sugar and energy. While Cosan is the largest natural gas distributor in Brazil, it is also a leading producer of biofuel, which is seen as a viable alternative to fossil fuel for road-based transport. Another company in this space is Reliance Industries, a leading producer of energy, petrochemicals and natural gas in Mumbai, India. Reliance is enjoying high margins as oil market adapts to supply disruption.
Sectors Expected to be Challenged
Industrials
Companies with rising input costs have been hit by profit taking, and companies that use commodity inputs such as aluminum, steel and petrochemical products are likely to continue to face an uphill battle.
Despite these challenges, we see opportunities in companies such as CATL, a global leader in lithium-ion battery development and manufacturing based in China. Demand for lithium-ion technology in electric vehicles and energy storage has quickly increased over the past decade and is expected to continue through 2030. We also see opportunity in WEG, a Brazil-based provider of electric motors, controls, panels, transformers and generators.
Information technology
There has been broad-based weakness in technology stocks as fears of a US-led recession weigh on demand expectations. This is especially evident in the smartphone supply chain, which is both consumer-facing and experiencing higher-than-normal inventories. While the sector has seen its challenges, not all companies face the same level of risk. Areas such as IT services continue to report strong results as businesses continue to invest to improve their digital capabilities.
The global semiconductor industry is another area led by emerging market companies. We continue to see opportunity in various semiconductor companies such as TSMC, Samsung Electronics, and SK Hynix.
Consumer sectors
Several Asian countries continue to face disruption from outbreaks of Covid. In particular, China’s “zero Covid” policy continues to disrupt businesses in the country as local lockdowns are implemented to stop transmission of the virus. As a result, factory workers and other employees are physically restricted from continuing to work.
We continue to see long-term value in companies such as Titan Industries, which is a luxury jewelry brand in India that is using technology to allow browsing of its online collections before completing purchases. We are also closely watching Alibaba, the world’s largest online retail commerce business in terms of gross merchandise volume. Its strong ecosystem and large user base provide excellent potential future monetization opportunities.
Conclusion
The market consistently undervalues high quality, sustainable growth companies in emerging markets. Even in a challenging macro environment, we believe strongly in the investment case for emerging markets. The current market valuation discount relative to developed markets makes a compelling investment opportunity for companies in emerging market economies. Given the evolving macro and geopolitical environment, a focus on strong ESG characteristics will be crucial in determining which companies can stay ahead of the curve in the long run.
About Alastair Reynolds
Alastair has been investing in equities for almost 30 years. He joined Martin Currie in 2010, when Martin Currie expanded its commitment to the Emerging Market asset class. In addition to managing investment portfolios and conducting investment research, Alastair is also responsible for the overall management of our Emerging Markets team.
During his career, Alastair has managed a broad range of emerging market equity strategies, including frontier markets and small caps. Prior to Joining Martin Currie, Alastair worked at Scottish Widows Investment Partnership, Edinburgh Fund Managers and Scottish Amicable Investment Management.
He is an associate of the UK Society of Investment Professionals (ASIP), the predecessor of the CFA Society of the UK.
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