Harnessing emerging market opportunities: key considerations
In recent years, emerging markets have been led higher by a small number of well-established Asian technology names. However, just as in the developed world, market leadership in emerging markets is showing signs of shifting. To access the most compelling opportunities in the years ahead, Andrew Lister, manager of the Aberdeen Emerging Markets Investment Company, suggests five key considerations for investors today.
Don’t be spooked by short-term noise
Developing countries are invariably the subject of troubling headlines from time to time. At any given moment, it is almost always possible to fixate on weak governance or volatile politics in one of the fifty odd countries that make up the broader emerging and frontier market universe. This is particularly true today, as the Covid-19 virus works its unpredictable way around the globe.
However, these headlines will often have little bearing on the long-term trajectory for individual companies operating in those markets. If anything, negative headlines should lead investors to be curious rather than fearful: market volatility often presents attractive entry points into emerging markets for investors willing to look beyond short-term uncertainty.
Don’t dismiss them as peripheral
Many investors underestimate the economic relevance of emerging markets. These are vast economies, home to 80% of the world’s population, yet they remain widely underrepresented in global stock markets. China remains on track to overtake the US as the largest economy in the world within the next decade, and yet its share of the MSCI All Countries World Index is less than 5% . If anything, Covid may have exaggerated this gap: in aggregate, emerging market economies shrank less in 2020 and are accelerating faster as the global recovery builds in 2021.
The growth story is not just about China. Non-China emerging markets now account for around 40% of global GDP growth. China adds another 30%, leaving emerging markets delivering more than 70% of the world’s economic growth. Investors’ allocations today are inconsistent with the scale of the opportunity set and its likely future growth. We believe that there are potential rewards for investors getting ahead of this trend.
Unfashionable sectors offer attractive valuations
There are many ways to access emerging markets and, in recent years, passive investment has proved to be a popular option. This has worked well, as markets have been led by a narrow selection of growth companies with significant weightings in the index. However, today we see a swathe of unloved and unfashionable areas of the asset class trading at attractive valuations. This is the result of typically more cyclical sectors like commodities and financials underperforming highly valued technology companies for a prolonged period. Similarly, small caps have been weak against large caps, non-Asian markets have significantly underperformed Asia and frontiers markets have also endured a period of weak returns.
Emerging markets are inefficient, much more so than developed markets. There is less analyst coverage and pricing is more erratic. In the longer term this should be a real opportunity for active managers to uncover pockets of opportunity. We believe the trend for China, Korea and Taiwan to dominate performance tables is likely to ebb from here and a lot of the excitement in emerging markets will be found outside this North Asian block. With this in mind, it may be worth considering an active option for the years ahead to capture these opportunities.
There is income potential
Emerging markets are surprisingly fertile ground for income seekers. Many emerging market companies have not been forced to make the same level of dividend cuts as numerous developed market companies during the crisis. In many cases, they have benefitted from lower indebtedness and more resilient earnings.
For those who would rather balance the volatility of an equity-only emerging markets portfolio, the inclusion of emerging market bonds may be an option. This bonds universe has expanded significantly in the last couple of decades, giving investors far broader choice. Plus, in times of low rates in developed markets like we have seen recently, yields are generally higher for developed market bonds.
Don’t think you’ve missed out
It may feel like emerging markets’ strong run of performance from the lows of 2020 is short relative to their earlier time out of the spotlight. However, the weaker US Dollar of the last year hasn’t yet been reflected in noticeably stronger performance from emerging market currencies and stock markets; this makes us optimistic that, over time, there’s plenty of scope for emerging markets to recover further lost ground relative to developed markets.
Investors have only just started to reallocate to the asset class. This could continue as investors reassess the prospects for emerging market equity against developed market equity. We believe many developing economies will emerge from the crisis with less debt and stronger prospects than their developed market peers.
There will always be reasons for investors to avoid emerging markets. Hopefully, the above points emphasise that the balance of risks and rewards is potentially favourable for investors considering investing in the asset class at present.
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- The Company may charge expenses to capital which may erode the capital value of the investment.
- Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
- Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
- With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘sub investment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.