Is it time to rethink your emerging markets investments?

What you’ll learn:

• Is the emerging market growth (EM) story set to continue?
• Will the pandemic reverse EM growth?
• What are the investing trends which will shape the emerging markets?

The pandemic is making us re-think many important aspects of our lives and this should include our investment thinking.

One such area is emerging markets (EM). We have seen incredible growth here over the last few decades. There has been a move from agricultural jobs to service sector and industrial roles while people have moved from the countryside to cities. Below, we show how Chinese growth compares to US growth.

To highlight this move, in 1950, there were just two mega cities globally; each with a population of over 10 million. In a study by the World Economic Forum in 2018, there were 33 mega cities identified globally, and 22 of these were in Asia and Africa. The move into cities has been one of the engines of growth in emerging markets.

But when you consider the gross domestic product (GDP) per capita, China still lags some way behind the US. So, is this growth story set to continue? Or, will the pandemic reverse this?

A history of emerging markets investing

It is worth taking a step back to understand where we have come from. The term ‘emerging markets’ was coined by Antoine Van Agtmael of the World Bank to define a country with low to middle per capita income. Countries are also defined as EM depending on the degree of development of their financial markets. This was in 1981 – not even a generation ago – but the current economic and investment landscape has changed significantly since then.

You can see this in the EM stock market index. The MSCI Emerging Markets Index, which tracks EM shares, was launched in 1988 and included 10 countries with a weight of about 0.9% in the Global MSCI ACWI (All Country World Index). In 1988, the largest constituents were Malaysia (32%) and Brazil (21%), forming over half of the index; China was not even included. Currently, the index captures 26 countries across the globe and has a weight of 12% in the MSCI ACWI. China has moved from not even featuring to being 40% of the index.

The other key factor in EM investing is the change in the sector weighting – 2020 has taught us the importance of returns from different industries. When the EM index was launched, commodity and materials companies formed over half of the index – materials are now 7% and energy 5% of the index. The emergence of technology can also be seen. In 1988, technology was 7% of the index – this is now 20% and the top names in the index are the Chinese and Asian technology stocks: Alibaba, Tencent, Taiwan Semiconductor, and Samsung.

The investing trends shaping the emerging markets

The first trend is technology. China’s goal of building a self-reliant technology industry has been elevated to become a strategic pillar. Under the ‘dual circulation policy’, China aims to boost innovation and move Chinese firms up the global value chain. As part of the response to the pandemic, China has again launched an infrastructure programme. This is a familiar playbook from the Chinese – we saw a large infrastructure package in response to the financial crisis in 2008, but this was focused around transport and transport hubs. While the infrastructure package will again include the transport sector, much of the money will go into ‘new infrastructure’, green energy, 5G networks, big data centres, and electric vehicle charging stations.

The adoption of this policy is also crucial. The younger demographic which we have seen in many EM countries has helped here. Also, systems are simpler. In the UK, vendors need systems to accept payments using Apple Pay. But in China, payments can be made by scanning QR codes – these are everywhere – even street musicians have QR codes. These payment systems have been developed by the technology giants Alibaba (Alipay) and Tencent (WeChat Pay). After the pandemic, the Payment & Clearing Association of China launched an action to encourage people to use mobile payments to avoid the risk of infection, which has increased adoption.

In addition to technology, the other big trend in 2020 has been ESG (Environmental, Social and Governance) investing. Investors are demanding additional scrutiny both in terms of the role of companies in society and how they are managed. This has been impacting EM in different ways.South Korea has been looking closely at corporate governance structures. South Korean shares do not get much respect from investors due to their governance and ownership structures. Many large Korean companies are family-owned conglomerates, or ‘Chaebols’. These include some of the largest businesses, including Samsung and Hyundai. The Financial Conglomerates Supervision Law limited major shareholders’ voting rights. Business groups that qualify will come under tighter regulations to improve their internal controls. This is an attempt by the South Korean government to make companies more shareholder friendly.

While South Korea is taking action on governance, the spotlight in Brazil has been on environmental issues. The recent Amazon fires have highlighted the concerns of investors and the government. To show their commitment, the Brazilian government hosted tours for investors highlighting the work which they are doing. The Brazilian stock exchange has developed a Corporate Sustainability Index to measure the average stock performance of companies to adopt sustainable policies. There is now a far greater awareness among companies of the need to adhere to ESG criteria, especially for those companies wanting to raise debt and equity internationally.

Does this focus on ESG help investors? Many studies have been published to try to establish the link between ESG attributes and financial performance. In an article¹ which summarises the results from 60 distinct review studies, the authors emphasise the difficulties in trying to generalise over many different studies. Nonetheless, they report that about half of the published studies show a positive link between corporate social responsibility and corporate financial performance.

Where to from here?

We know that EM countries have been impacted in the pandemic. Weaker health systems, lower social safety nets, lower financial support to individuals, and exposure to global trade have not helped but investors are currently looking through the pandemic. From September 2020 until the end of the year, we have seen week-on-week inflows into EM equities and bonds².

The obvious attraction is Asia and China where we are seeing a more advanced recovery as a result of manufacturing, the consumer, and increases in trade fuelling the recovery. But there is a longer term question of the opportunities in EM companies and in particular how they are represented in global stock markets. To highlight this, emerging countries now account for more than 58%³ of the world's economic output but their stock markets are worth, in aggregate, only 12% of the MSCI ACWI. There is an obvious disparity here.

There is then a question of how to access these investment opportunities. As we have discussed, there are very different issues facing this wide and varied asset class. In China, many of the businesses are nationalised companies (often called ‘state-owned enterprises’, or ‘SOEs’ in this context) – where the government has a majority holding – but which are also listed on the Chinese stock market to allow these companies to raise funds. But the question for investors is: do they prefer companies who are part-owned by the government or a privately-owned company, which will be run to maximise shareholder returns?

We think there are two actions for investors. Firstly, to consider the allocation in your portfolio – does this reflect the opportunities available? We think there are opportunities in both the emerging market equity and bond markets. Also, given the wide and varied asset class, we also think investors should seek out those active managers who can allocate capital to those companies with the greatest opportunity set and avoid companies where the governance and objectives do not align with shareholders. However, it is important to remember that investors in emerging markets often face greater risks and uncertainties than investors in more established markets.

Where to invest

We believe that the best way to achieve your long-term investment goals is to have a diversified portfolio. To help you we’ve created our Funds List – it’s made up of funds we like from the sectors we believe are key to building a diversified portfolio. Within each sector, there’s a mix of investment focus and investment approaches to choose from. So why not take a look at our selection?

Two funds which we like are the JO Hambro Global Emerging Markets Opportunities Fund and the Ninety One Emerging Markets Equity Fund. What makes the JO Hambro fund different to the majority of emerging market funds is that the team places great emphasis on country allocation, which they believe is a major driver of performance. Meanwhile, the team at Ninety One look to identify high quality companies (that exhibit, for example, strong management, robust earnings and growing cash flows) that are attractively valued.

To diversify your investment, you may like to consider our own Barclays Ready-made Investments (RMI). The RMI are just one example of a range of diversified funds which allow you to select the level of risk you are most comfortable with. These multi-asset funds invest in passive funds across a range of asset classes and regions, offering a globally diversified one-stop solution for investors. Ready-made Investments are not the only funds that we offer and they won’t be appropriate for everyone.

Whichever option you choose, you must accept that all investments can still fall in value as well as rise and you might get back less than you invest.

We don’t offer personal investment advice so if you’re unsure you should seek that independently.

Funds are designed for the long term so you should only consider them if you can stay invested for at least five years.

These are our current opinions but the future, as ever, is uncertain and outcomes may differ.

Read the Assessment of Value report [PDF, 683KB] for funds run by Barclays.