Key Points
- Economic growth in developed markets is starting to decelerate, while growth in emerging markets is relatively stable.
- We believe emerging-market equity valuations are compelling compared to those of developed markets.
- At the company level, we see innovation driving growth opportunities, stronger balance sheets and more resilient management teams, which have learnt how to operate in a challenging environment.
The last decade has been disappointing for investors in emerging-market equities, which have broadly lagged their developed-market counterparts. Looking ahead, a combination of cyclical and structural factors drives our more constructive outlook on emerging markets.
From a cyclical viewpoint, the economic growth differential between emerging markets and developed markets is improving in favor of emerging markets, and our view is that this enhances the overall attractiveness of emerging-market equities.
While the global economy has remained resilient, growth in developed markets is starting to decelerate, while growth in emerging markets is relatively stable, in contrast with much of the last decade. Of course, question marks remain over China. Although the country’s reopening has been disappointing, there are now encouraging signs of a cyclical bottoming.
Opportunities Driven by Innovation and Inclusion
As a long-term investor, structural changes are hugely important. The challenges of the last decade have driven significant innovation in products and services across emerging markets as companies look to meet growing and evolving demand. Technology adoption and digitalization are enabling increasing efficiencies across industries and the inclusion of marginalized segments of the population into the broader economy. At the company level, we see stronger balance sheets and much more resilient management teams, which have learnt how to operate in a challenging environment. This, we believe, is ultimately translating into unique investment opportunities, as many companies have the potential to grow strongly by addressing domestic demand, as well as to grow market share in global industries.
Attractive Valuations
We consider these structural growth opportunities against a backdrop of attractive valuations. Global emerging-market equities currently trade at a price-to-earnings ratio of 11x, which we view as attractive on an historical basis, and inexpensive compared to developed markets.
The inflation outlook is interesting. On a short-term cyclical basis, we are seeing inflation in emerging markets starting to moderate. In fact, several emerging-market central banks have led the way in cutting interest rates. At the same time, we appear to be getting closer to the point at which the US Federal Reserve holds interest rates, and this could help to moderate the strength of the US dollar, which has a significant impact on emerging markets.
Inflation to Remain Structurally Higher, Owing to Decarbonization and Supply-Chain Diversification
In our view, the structural aspect of inflation is equally important. We think we have entered a period in which inflation will remain structurally higher for longer. Decarbonization and diversification of supply chains are among the factors contributing to structurally higher inflation.
In developed markets, companies are grappling with how to operate in this new market regime of structurally higher inflation. However, this is a market regime that emerging-market companies are very familiar with and know how to navigate.
It is also important to acknowledge the influence of geopolitics on the outlook. Geopolitical tensions and a more volatile macroeconomic environment drive controversy and a higher dispersion of returns. This has the potential to provide strong opportunities for active investors in less efficient emerging markets.
Innovative Companies That Address Long-Term Structural Demand
Our focus is on identifying long-term sustainable growth opportunities across emerging markets. This drives us to invest in innovative companies with durable franchises and strong governance that are the beneficiaries of long-term trends. Our approach to emerging-market equity investment is thematic in nature and, ultimately, less correlated to traditional economic cycles across emerging markets.
We are targeting domestic champions, as well as companies that are taking share of global industries by successfully addressing long-term structural demand. For example, we have invested in a leading company that is working to increase automation in China, a key goal in a country facing significant ageing of its population. The company’s products are competing with global products by providing similar quality at competitive prices.
Advances in technology, coupled with the desire to spur economic development, are expanding the provision of financial services to previously ‘unbanked’ populations across emerging markets. We have exposure to several companies which can benefit from these tailwinds, including a fast-growing bank in Indonesia which provides micro loans to smaller companies.
Authors
Liliana Castillo Dearth
Head of emerging markets and Asia equities
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