Take time to examine the economic evolution in emerging markets

Developments in countries such as Russia, India, and Brazil are under-appreciated, argues Andrew Ness.

Maintaining perspective matters, particularly when we consider emerging markets. Despite ongoing US-China trade discussions, intra-emerging markets trade has blossomed in recent years with China replacing the US as the largest export destination for other emerging markets as a whole.

However, there has also been positive developments in other emerging markets that have flown under the radar.

Three decades ago, emerging market economies typically relied on commodity exports. Those exports drove economic development and manufacturing, and also contributed to the creation of global supply chains.

Since then, emerging markets have evolved through structural reforms and improved regulation, so we’ve seen improved resilience. In addition, heightened domestic demand has helped many countries grow irrespective of external forces.

However, we believe that there are still some emerging market developments that remain under-appreciated.

Misconceptions remain

Some common assumptions about emerging markets are not accurate. One misconception is that production processes of goods from these economies can often be unethical and poorly regulated. This can lead to concerns about the quality of goods, as well as reliability of services.

There may be an element of truth in this concern for some markets, but it’s not true of all emerging markets. We’d argue that it’s important to recognise the regulatory changes that have been happening in certain emerging markets to improve the market environment.

As investors, we recognise these and other macro developments, but also consider individual stocks from a bottom-up perspective.

When we’re examining investment opportunities in emerging markets, corporate governance is an important consideration. We take aspects such as quality management, ownership structure and history of business conduct into account. We also proactively engage with company management and other stakeholders to monitor corporate governance practices and promote positive change when needed.

Progressive Russian firms focus on shareholder returns

Some significant regulatory changes in Russia has led us to reconsider equity investment opportunities there. The Russian government has implemented some politically challenging measures, such as tax increases and pension reforms, with plans to raise productivity growth through higher spending on infrastructure, health and education.

 Several progressive dividend policies and strong buyback programs have emerged from Russia recently, but headlines have largely focused on geopolitical tension between the US and Russian governments. Over the years, we have worked with businesses in regard to governance factors. As such, some of these companies have increased their focus on shareholder returns.

Innovation in India

Emerging markets used to have a simple roadmap to growth: produce and sell abroad. Some countries offered large pools of affordable labour to become low-cost manufacturing hubs. This often left the fortunes of these countries vulnerable to changes in the developed markets that they exported to.

What today’s headlines fail to reflect is that emerging market economies have evolved. As they become increasingly more developed, they are growing their “high-tech” exports to meet growing global demand.

In India, for example, innovation has become a priority. Its national strategy “Decade of Innovations 2010-20” is committed to strengthening science, technology and innovation capacities. Its objective is to increase gross expenditure on research and development to 2% of India’s gross domestic product by 2020. The country’s commitment to innovation is also reflected in India’s “Make in India” initiative to strengthen its manufacturing sector.

Brazil’s environmental considerations

In Brazil’s manufacturing sector, we’ve seen certain companies make considerable progress in regard to environmental considerations, which are starting to influence business decisions.

One Brazilian auto parts manufacturer has worked to significantly reduce its carbon dioxide emission through the introduction of alternative biofuels (ethanol) in its internal combustion engines. The company has taken this a step further to develop a solution to improve ethanol productivity at its sugar cane mills.

We believe that this should further improve the use of renewable fuels in Brazilian cars, which are already mostly dual-fuel vehicles that run on more than one type of fuel, that is, gasoline blended with either ethanol or methanol fuel.

Learning lessons from the past

We remain primarily focused on individual company fundamentals to assess long-term prospects on a case-by-case basis.

We tend to favour high-quality and sustainable companies where we see long-term potential. Our teams on the ground identify potential opportunities; our local reach is particularly useful when we consider the potential opportunities in relatively untapped segments of the market.

We that believe today’s emerging markets are more resilient than in previous decades, emerging stronger after periods of economic hardship, such as the Asian financial crisis in 1997 that affected much of South-east Asia.

Many emerging economies learned lessons from the past, building up cash reserves and diversifying away from US dollar-denominated debt.

Conclusion

The emerging markets of today bear little resemblance to the emerging markets of 1989. Since that time, emerging markets have become far more outward-looking, while also developing stronger trading relationships with each other.

We encourage investors to look beyond the headlines to see how emerging markets have become resilient, stand-alone economies.

Andrew Ness is portfolio manager of Templeton Emerging Markets Investment Trust.

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