There’s beauty in diversity
Author: Regina Chi
March 22, 2019
Emerging Markets shouldn’t be viewed as a single asset class
There was a time, back in the 1990s, when Emerging Markets all seemed to be working from the same playbook. But these days, many EM countries are busy carving out their own path to the future while rewriting an outdated script.
Still, the perception that EM is one homogeneous asset class persists despite its evolution as a diverse group of countries with different opportunities, as well as risks and drivers. EM economies are evolving and many are stepping up the value-chain, each with their own economic cycle, political realities and market structure.
And while a number of macroeconomic forces sideswiped EM markets in 2018, many of those headwinds are now shifting to tailwinds. Not only are valuations in EM favourable, but GDP growth is forecast to outstrip that of Developed Markets in 2019. The upshot? There are lots of reasons for optimism as we look to EM this year. Yet, investors would do well to pick their spots, balancing the opportunities against the risks while investing in disparate EM countries.
The EM that was
Back in the 1980s and 1990s, EM countries were largely commodity-based economies, often with large account deficits—meaning they owed debt in US and European currencies making them particularly vulnerable to external macroeconomic policies. Early investors, who were initially intrigued by rapid rates of industrialization and soaring growth rates, later got spooked, caught in the cross-fire of a string of financial crises beginning with the Mexican Peso Crisis in 1994, followed by the East Asian financial crisis in 1997, and the Taper Tantrum in 2013. These shocks set off a negative chain reaction in the global economy, yet ultimately proved to be the catalyst for sweeping reforms in many EM countries. India, for example, began opening up large parts of its economy to foreign investment. Meanwhile, significant fiscal and monetary reforms were implemented in Asia, culminating in China’s entry into the World Trade Organization in 2001.
Rise of the new EM
Fast-forward to 2019 and the picture takes on a remarkably different and nuanced hue. Infrastructure-driven sectors, like industrials, materials and energy, are less important drivers of performance, while many EM economies have shifted into a new generation of growth based on technology and innovation, with a focus on higher value-goods and services. The recent explosion of China’s technological firepower, for example, coupled with its new strategic plan, Made in China 2025, has given rise to a designed-in-China model, some call “Chinnovation.” Meanwhile, other countries and regions like those in Latin American and South Africa are endowed with natural resources and still in the early stage of their development.
Reform is ongoing. Many countries are now issuing bonds in their own currencies, for example, while slashing debt loads and current account deficits. Many have also pursued other structural reforms to enhance fiscal discipline and shield their economies from external shocks, while bolstering markets for the future. Yet, other countries continue to be plagued by precarious economies and institutions with persistent structural imbalances.
By the numbers
A comparison of sector weightings on the MSCI Emerging Markets Index—representing 24 countries—tells the story of EMs remarkable transformation between 2008 and 2018. In 2008, for example, IT accounted for 10% of the Index, versus 27% last year; energy represented 19% in 2008, compared with 7% last year; and materials have fallen in their weighting to 8% from 16% a decade ago, according to MSCI figures.
Perhaps the most significant gauge of the current heterogeneity in EM, however, is the dramatic variance in stock market returns between countries. Over five years, between the end of January 2014 and as of January 31st, 2019, India’s market returns were up 79%, compared with 53% for Brazil and a decline of 10% in Turkey. Growth rate forecasts for 2019 are also widely divergent: 2.8% in South Africa, 5.1% in Egypt, and 7.5% in India, Bloomberg figures show.
With so much diversity, EM offers a unique opportunity to invest in a faster-growing and more diverse range of countries and sectors, yet this requires a selective approach, balancing opportunities against risks. In other words, prudent investors would be wise to recognize not just the beauty but the strength in EM’s diversity, while pursuing a long-term strategy.
Regina Chi is Vice-President and Portfolio Manager at AGF Investments Inc.
About AGF Management Limited
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