Now is the Time to Revisit Emerging Markets

2018-11-08T15:41:09+00:00October 1st, 2018|Insights|
  • In 2016, China and India had 4.7m and 2.6m STEM (Science, Technology, Engineering and Mathematics) graduates. The United States and Japan had 568,000 and 195,000 respectively
  • From 2000 to 2017, the number of internet users in Africa has increased from 4.5 million to 453.3 million – an increase of 9,973%, or an increase of 31.2% a year for 17 years
  • Distance between London to Edinburgh: 534 km. Fastest route by train: 4 hours 14 minutes. Distance between Shanghai and Beijing: 1,318km. Fastest route by high speed rail: 4 hours 18 minutes

When I first started investing in emerging markets (“EM”) in the 1990s, the landscape looked very different.

Back then, emerging markets had unsustainable levels of debt, unpredictable politics, inexperienced central bankers and were heavily reliant on the developed world. Companies focused on low-cost manufacturing and had very basic corporate governance, lagging far behind those in developed nations.

Today, the landscape has changed entirely. Populations and living standards have ballooned, creating enormous middle classes with growing consumption levels. Governance has improved significantly, with shareholder engagement and activism not just supported but actively encouraged by companies and governments alike. Most crucially, emerging markets now offer a dramatically more attractive set of companies. These businesses and management teams no longer follow – they lead.

Now is the time to revisit emerging markets

Many market participants have been holding off investing amid the recent volatility, particularly in view of falling emerging market currencies. While it can be argued that weakened currencies make it more difficult for EM firms to keep up with hard currency interest payments, we should also acknowledge that this offers more attractive prices for overseas investors.

Valuations remain far too low across the board in my view with EM forward P/E multiples at just 11.4x – lower than in 2009 and 2007, and far lower than the >15x multiples we saw in the 90s. There is a real opportunity for investors to identify firms that are unfairly dragged down by concerns that are no longer relevant today.

For example, both private and public debt levels in most emerging markets are far lower than the levels we saw in past debt-driven crises. This mitigates concerns about the rising cost of hard currency interest payments. Even in the case of companies with high levels of debt, active investors can carefully run through individual company balance sheets and talk to management to identify firms that are able to protect themselves.

Second, although we are finally seeing an uptick in EM inflation after nearly 20 years of decline, this will not lead to the wild levels we saw in previous decades. Inflation will be kept in check by factors such as more prudent and proactive monetary policies. Furthermore, economies of scale, both from technological innovation and from population growth, enable producers to cope better with fluctuations in demand.

Third, there has been a notable shift from traditionally export-driven industries such as textiles, towards sectors such as technology that tap much more strongly into the home market. When I go to trade shows today it is the EM companies that have started to dominate in areas such as robotics and high value component manufacturing. Cutting-edge innovation is particularly coming from Asia, rather than from developed markets. This has resulted in increased profitability as well as higher R&D levels among EM players.

These developments combined with the enormous increase in population and internal demand, make EM companies today far less dependent on international trade. Intra-EM and especially intra-Asian trade is a common characteristic for a number of sectors such as technology, fashion, shipping and media.

In China, technology ‘unicorns’ are being born with increasing frequency, without ever leaving the domestic market. In Indonesia, entire sectors (such as banking) remain undeveloped, offering numerous multi-billion-dollar markets to tap into for South East Asian companies that can combine cultural and domain expertise.

These sorts of domestic and regional growth opportunities, regardless of what happens in developed markets, offer resilience at a time when many are concerned about fallout from the ongoing trade war.

Fourth, and a point of interest from an asset allocation perspective, is that EM flows are no longer solely driven by broad-sweeping sentiment, but rather by specific themes, sectors, and specific exposure to macro events. We see investors evaluating each country individually on its potential to learn from previous lessons in their approach to policy and governance.

Take Mexican equities, for example.

With Carlos Urzua’s appointment as finance minister, equity markets greeted his intentions to slash excessive salaries and corruption enthusiastically. The S&P/BMV IPC Index has seen a 10% gain through June and July, despite emerging markets having fallen overall (the MSCI EM Index fell about 6%).

Even the recent sharp currency swings have varied from country to country. South East Asian currencies such as the Singapore and Taiwanese dollar have held steady, compared to sharp declines for the Argentine Peso and Brazilian Real.

Finally, and perhaps most importantly for Mobius Capital Partners, we are entering a period of improvement in ESG (environmental, social, and governance) standards. The appetite of emerging market companies for investment puts them under pressure to respect governance principles.

From poor capital allocation and misaligned incentives to unsustainable supply chains, there is enormous potential to drive positive change across the board. As governments introduce progressive policy changes, companies are starting to listen. This is the time for investors to be as active as possible.

It is our firm belief that these four trends present a unique opportunity for a concentrated and diligent approach, focusing deeply on the specific drivers and nuances of each individual company and country. Emerging market economics and companies are extremely well-positioned to generate significant and sustainable real earnings – if they make the right decisions.

Now is the time to revisit emerging markets.

Some further interesting facts about emerging and frontier markets:

  • In the last 9 years, the number of universities from emerging markets ranked in the top 100 has more than doubled, from 6 to 15
  • Since the fall of the Berlin Wall towards the end of 1989, the number of African countries that hold multi-party elections has increased by 2.6 times – from 19 before, to around 50 today
  • In 2017, it is estimated that the median age in the Philippines is 23.5. In Bangladesh it is 26.7, in Nigeria 18.5
  • According to Transparency International, 75 out of the 100 of emerging market multinational companies it assessed in 2016 scored less than 5 out of 10 in terms of transparency
  • In China, for 2017, the use of natural gas grew four times faster than oil, +15% to +3.9%

Sources: QS World University Rankings, CIA World Factbook, World Economic Forum, Internet World Stats, Transparency International, BP Statistical Energy Review, Travel China Guide