Making a case for emerging markets (EM) investing has never been straightforward.
Indeed, a series of shocks have repeatedly driven investors to withdraw their capital, causing a pattern of boom and bust.
Doubts still linger over how many EM countries can actually achieve developed status, or the justification for investing in emerging market equities from the standpoint of returns.
But none of this necessarily means investing in emerging markets isn’t worth it. On the contrary, there are many signals that the best may be yet to come.
Growth on the horizon
When the case for an allocation to emerging market equities is made these days, it usually centres around relative valuation. This argument is increasingly being supplemented by a new-found appreciation of emerging markets’ macroeconomic resilience.
Sure enough, we have just gone through the most aggressive Fed tightening cycle in a generation, and most of the major emerging economies have sailed through unscathed.
But the case for growth in emerging markets isn’t being discussed nearly enough.
We are constantly told that the golden age of globalisation is at an end, and that emerging markets, as the biggest prior beneficiaries of this trend, will be the most challenged by its reversal.
Yet what we are seeing is not de-globalisation, but de-Sinification as the west seeks to grind China out of its system. There will be winners elsewhere in emerging markets as supply chains adjust, new export champions emerge.
A shifting centre of gravity
Equities in Mexico, South Korea, Vietnam and India are finally attracting more attention after a decade of neglect.
That’s because when it comes to the key challenges we are likely to face in coming decades, many of the answers are in the developing world.
If you think about the transition to renewable energy, we're going to require an awful lot of critical minerals, copper and nickel.
If you think about developed markets reviving their manufacturing sectors, we’re going to need an awful lot of steel and cement. And if you think about AI, we’re going to need lots of semiconductors.
When you think about all those things, the idea that the world's centre of economic gravity will continue to tilt towards emerging markets seems very plausible.
Macro matters
Some investors will tell you that macroeconomics doesn’t matter, it’s all about finding great companies and focusing on fundamentals. But it does matter in emerging markets.
If you pick the right companies at the wrong moment, currency moves and stricter lending criteria can send the value of emerging market stocks into a tailspin. But the results can be stellar when both factors work in your favour. And there are signs to suggest such a period is on the horizon.
We’re still below the 2007 peak in the MSCI Emerging Markets Index and more capital has left emerging markets than has flowed in for the best part of a decade.
The result is that asset prices appear undervalued compared to other markets. And from emerging markets, more and more world-class companies are appearing.
World-class companies
Take Taiwan Semiconductor Manufacturing Corporation, better known as TSMC. It has close to a 60 per cent market share in manufacturing chips for third parties, and counts Apple, NVIDIA and Qualcomm among its biggest clients.
In the 1990s, it was about twice the size of its nearest competitor, United Microelectronic Corporation. Now, it’s six times the size.
Nobody knows which AI applications will be most successful, but we have a good idea that TSMC will be making the semiconductors powering them. The market still misses how much value it could create.
India, too, has many promising startups, while its larger brands benefit from the public’s growing disposable income.
Much of this potential is already reflected in valuations. However, Jio Financial Services is one example of a company whose prospects are particularly bright.
There are hundreds of fintech companies in India. What makes this one special is that it’s backed by Reliance Industries and has access to all its data. We’re talking about 400 million telecoms customers and 200 million retail customers: that’s a powerful combination.
Patience can be profitable
If the early 2000s were about the integration of China and the west, the 2020s are poised to see something much broader: four billion people in 100-plus EM countries that are doubling down on trade with both sides of the geopolitical divide.
Evidence of this is already becoming economic reality, as emerging market countries trade with each other more than ever, further liberating emerging markets from their historical dependence on US policy.
The profits from this new wave of globalization are likely to be reinvested into emerging markets themselves. It could be a far more powerful and self-sustaining trend than anything that has unfolded before.
Will Sutcliffe is Head of Baillie Gifford’s Emerging Markets Equity Team. He joined Baillie Gifford in 1999 and became a partner of the firm in 2010. Prior to joining the team in 2001, he spent time working in our UK and US equity teams. Will graduated with MA in History from the University of Glasgow in 1996.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our most recent white papers.
© Baillie Gifford
Read more commentaries by Baillie Gifford
