They’re back: emerging markets

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They’re back: emerging markets

Emerging markets have been top of investors’ wish lists for the reflation trade: $17bn flowed into the asset class in the first three weeks of the year as global investors looked for ways to take advantage of the global recovery. Does this mark the end of a long period when the asset class has been overlooked by investors?

Certainly, many of the most compelling trends in emerging markets haven’t gone away: the consumer is going from strength to strength; demographics are still in their favour; infrastructure building and urbanisation are contributing to economic growth and technical innovation continues apace. At the same time, improving governance is making them an easier place to invest.

Equally, most emerging markets haven’t performed badly during their period out of the limelight. Most have delivered reasonably well for investors over the last five years, just not as well as the S&P 500. However, it means that as people revisit the asset class, they may be pleasantly surprised. China, Korea and Taiwan, in particular, have been strong performers over the last year.  

The US dollar is likely to be important in the relative ‘stickiness’ of assets in emerging markets. With a vast stimulus package on the table from the new Biden administration, the US dollar has weakened. This is likely to broaden the appeal of emerging market currencies and emerging market assets more generally in 2021.

Once investors have warmed up to the asset class, a second question will be where to direct their capital. On the one hand, there is China, with its large technology companies and compelling economic growth; on the other are the commodity producers – Brazil, Russia, South Africa – which have performed poorly during the pandemic but may now be poised for a revival as the global economy picks up.

 

China and the index problem

Many of those coming back to emerging markets have sought to focus exclusively on China. This is perhaps understandable: it has seen a strong pandemic response, its economy has held up well, its stock market was second only to the technology sector for 2020. It now constitutes 40% of the MSCI Emerging Markets Index and six of that index’s top ten holdings are from China.

However, to our mind, a narrow focus on China is a mistake. It is an area where investors should be spreading risk. It is still communist, some of its debt metrics still look frothy and it could be the first global economy to start monetary tightening, not least to minimise the risk of bubbles in, for example, the real estate and equity markets. We have also seen some excess building up in the ‘A’ Shares market as private investors have taken a greater interest.

A focus on China also risks missing out on some of the other good growth stories in emerging markets. There are large swathes of emerging markets that get much less attention – Africa, Eastern Europe, Latin America and the Middle East. These have largely been overlooked in recent times, particularly during the pandemic and yet it’s in many of these markets that valuations look most compelling and opportunities most abundant.

We would caution that while there can be little doubt that China will continue its unstoppable rise in global prominence and China’s economic growth has smashed even the most optimistic estimates, any sound emerging market investors needs to consider the broader universe of close to 40 countries.

 

Poised for revival

It isn’t so long since many people were saying there was little future for the extractive industries. The planet was going green – there was no room for mining in this brave new world. This inevitably had an impact on those emerging markets where commodities form a large part of their economy.

This has come full cycle. It is increasingly clear that the energy transition cannot take place without the extractive industries. They can’t make electric cars without lithium, while renewable energy infrastructure is uniquely dependent on copper. The green revolution needs metals to make it happen. Increasingly, we see countries such as Brazil, South Africa and Russia as beneficiaries of a renewed focus on sustainability rather than victims of it.

 

Local champions

The US technology giants have had great success in developed markets across the world, particularly during the pandemic. Investors have come to rely on Amazon deliveries for their shopping, or Microsoft Teams for remote working. However, they have not achieved the same penetration in emerging markets, where barriers to entry are far higher.

It is often local champions that stand in their way. In Russia, for example, there are sanctions in place from the US, so there can be no Amazon. This has allowed domestic companies to flourish. Through an investment in a Russian private equity fund we benefitted significantly from two Initial Public Offerings (IPOs) in late 2020.The first to go public was a Kazakh company that listed in London in October, Kaspi. This is Kazakhstan’s answer to PayPal. Ozon listed in New York in November. This is Russia’s leading online marketplace. Both names have seen explosive growth and have vast addressable markets, but are not talked about in the same way as their Western equivalents.

This is a trend across emerging markets. It is possible to find growth names, similar to those that attract such elevated valuations in the US market, but at far more realistic prices. We believe these anomalies will adjust as capital comes back to emerging markets. The IPO markets are already bouncing back to life, bringing new and exciting opportunities for investors.

 

Important information

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 ‘subinvestment 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.

Find out more at www.aberdeenemergingmarkets.co.uk or by registering for updates. You can follow us on social media here: Twitter and LinkedIn.

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