Although volatility, currency and political risk will remain part of the emerging markets package, the future for emerging markets continues to be brighter than it does for developed markets and investors should look to capture the potential.
That’s the view of Daniel Morris, senior investment strategist and Quang Nguyen, CIO, global emerging market equities.
‘Emerging market equities have put in several years of under-performance, the longest on record, which in itself argues for a continued turnaround in relative performance,’ the pair noted in an investment report titled The Future of Emerging Markets.
‘The perceived weaknesses of emerging markets — either a disproportionate exposure to commodities or a reliance on growth — turn out to be less relevant.
‘Longer term, the key drivers of emerging market growth remain intact, from faster GDP growth, better demographics, rising populations, an expanding middle class, and urbanisation, to structural reform and productivity gains.'
Overall, higher productivity growth, structural reform, an expanding middle class, urbanisation, and maturing capital markets all suggest the outlook for emerging market equities remains bright, according to the report.
Morris and Nguyen said in fact, the perception that EM equities are more dependent on commodities than developed markets is overestimated, and in China, a transition to a more efficient and balanced economy should offset a deceleration in export and GDP growth in relation to equity prices.
‘China has begun to shift its focus from capital deployment to achieving returns on its invested capital,’ they said.
‘No longer can China rely on the size of its population and GDP growth that it generated, China now has to find ways to maximize its return on allocated capital.’
The macroeconomic policy settings of the old way comprised of artificially low interest rates, an artificially low exchange rate and strict capital controls.
‘These policies are now gradually being replaced with more market-driven real interest rates that force greater efficiency and that will shift capital from state to more efficient private companies,’ said the pair.
Furthermore, there are other factors supporting China’s transformation, which shouold offset a deceleration in its export and a slowing down GDP growth in relation to equity prices.
For instance, according to the pair, China’s yuan has become a more market-driven exchange rate; the country has transited into a producer of value added / high margin products that are more technology intensive and less labour intensive; and China has exported cheaper value added products to its Asian neighbours, these countries will themselves become more productive, creating further investment opportunities.
In a period of lower growth globally, investors are putting a premium on whatever GDP expansion they can find, the report noted.
‘While emerging market growth is not as rapid as it was, it is, nonetheless, very likely to significantly outpace that of developed economies.
‘If forecasts by the IMF turn out to be accurate, emerging market GDP will be over 27% larger by 2021 while developed market GDP will only have increased by just 9%.
‘This difference represents a major opportunity for emerging market companies.’