Why emerging markets have become a better bet

Some emerging markets more secure investment prospects than developed regions

The past year has seen solid performance across most emerging markets, with impressive GDP growth, economic and technological developments, and improvements in earnings. In contrast, geopolitical risk in developed economies has increased, with uncertainty in Europe, especially with Brexit negotiations, and concerns surrounding US trade policy, as well as muted domestic economic growth in many mature markets.

Emerging markets have significantly outperformed developed markets, with the MSCI EM index up 33 per cent in the first 10 months of 2017, compared to a 19 per cent return in the MSCI World index.1 In my view, this is a mean reversion from a short period of underperformance back to the trajectory of outperformance which has been intact for the past 30 years, in which emerging economies outperformed developed markets by more than 1,400 per cent.

Emerging markets represent nearly 50 per cent of the world’s GDP measured in nominal terms, and account for more than 75 per cent of global growth in output and consumption. 2 Further, GDP growth in emerging markets is expected to continue to outpace that in developed markets, with the International Monetary Fund projecting growth of 4.6 per cent versus 2.2 per cent in developed markets in 2017. With this trend expected to persist, the attraction of the emerging-market asset class should be maintained.

In 2017 emerging markets have continued to progress, with several countries including Brazil, India and Argentina undergoing political and economic reforms. Brazil’s return to growth, monetary easing and clampdown on corruption, as well as the passing of labour reform legislation and expectations of economic and structural reforms, all bode well for the domestic equity market.

Overall, the general landscape of emerging market corporations has undergone a significant transformation. The rudimentary business models of the past (infrastructure, telecommunications, banking or commodities) have become a new generation of cutting edge and innovative companies that have shifted into technology and higher value-added goods and services. Furthermore, we are starting to see the establishment of global brands originating from emerging market countries.

The rising importance of information technology (IT) has also coincided with less dependence on commodities as drivers of growth. Technology and consumer companies have been steadily increasing over the years, with IT now commanding the highest sector weight in the MSCI EM index, at 28 per cent. This is a result of both recent outperformance and the rise of a number of large IT players, most notably Chinese internet companies.

IT companies in South Korea and Taiwan are also prospering. We are now seeing a growing number of patent registrations coming from emerging markets – more than from developed markets. In 2015, nearly half of all patent applications globally came from emerging markets, more than double their 20 per cent share in 2005. Meanwhile, the share of developed markets’ patent applications declined to just over half in 2015, from four fifths in 2005.

Desirable branded technology products

Increasingly, emerging market tech companies are not only supporting the products from developed markets with component or licensed device manufacture, but developing desirable branded technology products which are being exported to the rest of the world, gaining traction and market share.

At the company level, a broad range of emerging market companies are returning to strong earnings growth and adopting more robust corporate governance models. Yet despite encouraging growth, emerging market equity valuations have remained attractive compared to developed market businesses. As of October 2017, emerging markets traded at a 27 per cent discount to developed-market equities. 4 This has stimulated investment as well as improving performance, with 2017 witnessing strong fund inflows into emerging markets.

Supportive fundamentals plus discounted valuations should make emerging markets less susceptible to negative global news flow, as there is less ‘unwinding’ of trades than in developed markets.

Carlos Hardenberg is lead portfolio manager of Templeton Emerging Markets Investment Trust.

This article is one of our Original Thinker pieces, which are showcased in Money Observer’s annual wealth creation guide. The January 2018 issue of Money Observe now on sale at WHSmith, selected Tesco and J Sainsbury supermarkets and many independent retailers. To order online and ensure you pay the lowest rate per issue, visit our subscription page.


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