In 2021, as we move into the recovery phase of the coronavirus crisis, emerging markets are rebounding sharply. In this article we explore why you should consider investing in this space and the case for looking at some of the less well-explored options alongside the dominant Chinese market.

2020 proved a very up and down year for emerging markets (EM), which plunged to record lows in March amid the risk-averse sentiment in the wake of the pandemic – investors withdrew over $50 billion from EM equities in that month alone.

That presaged a remarkable recovery to pre-crisis levels in the fourth quarter driven by stimulus, positive vaccine news flow and Joe Biden’s victory in the US presidential election, seen as a potential step towards defusing tensions between the US and China. Year-to-date, emerging markets have continued to rally for a number of reasons.

Investors have recognised that emerging markets represent great value, while many developing countries have handled the pandemic effectively and a weakening dollar has provided a powerful tailwind.

While the current concern about inflation is prompting rising US bond yields and could see dollar weakness reverse, investors shouldn’t be put off emerging markets by any short-term blips – it’s about a much longer-term prize.

As the chart of MSCI World (representing developed markets) versus MSCI Emerging Markets indicates, gains for the latter have been materially greater though more volatile.

Dominating emerging markets indices is China, the gargantuan economic powerhouse that remains too big to ignore.

During 2020, China’s gross domestic product (GDP) expanded by 2.3%, making it the only major global economy to avoid a contraction last year. The big daddy of emerging markets continues to see the emergence of high-quality companies that are well-placed to benefit from ongoing market consolidation and booming domestic consumption.

As the Year of the Ox begins, China’s economy has already bounced back to pre-pandemic levels. With a decisive early lockdown, China has so far avoided the dreaded second wave currently felt in many other parts of the world.

Chetan Sehgal, lead portfolio manager for the Templeton Emerging Markets Investment Trust (TEM) believes that China will ‘most likely emerge stronger from this crisis’, as the pandemic has ‘reinforced key structural trends of increased institutional resilience, growth of consumption, technology, innovation, and the ability of companies to “leapfrog” developed-world competitors’.

But investors seeking to position portfolios towards the emerging markets that will power the economic growth of the future should consider looking at other markets alongside China, as opportunities abound everywhere from Africa, India and Vietnam to regions such as Latin America and emerging parts of Europe.

FACILITATING ACCESS TO FAR-FLUNG MARKETS

Funds are often a good way for investors seeking to harness opportunities in far-flung emerging markets. Professional portfolio managers have a better chance of assessing and mitigating the risks which come with emerging markets and of identifying the best opportunities.

Austin Forey, manager of JPMorgan Emerging Markets Investment Trust (JMG), says investors should ‘consider the growth potential of specific companies, rather than taking a view on a country’, when it comes to emerging markets. ‘People are key to our approach in uncovering tomorrow’s winners. We utilise our extensive network of country and sector specialists when unearthing opportunities, keeping a concentrated portfolio with low stock turnover.’

Increasingly, there is an encouraging trend in emerging markets, says Forey. ‘They are becoming more like developed markets, in the sense that the value creation in the corporate sector is being strongly driven by very similar factors in both areas.

‘Digitalisation, the development of internet-based business models, the creation of intangible value rather than reliance on physical assets and large amounts of investment in fixed assets – these are far more widely seen in emerging markets today than in the past, as, as can be seen simply by looking at the trust’s ten largest investments.’

LOTS TO LIKE ABOUT LATIN AMERICA

Ed Kuczma, manager of the BlackRock Latin American Investment Trust (BRLA), says that Latin American economies remain under owned and underappreciated by global asset allocators, though a new US administration and fresh stimulus package in the US could change things.

‘Mexico should be a significant beneficiary of a Biden presidency and the country is currently our largest active overweight in the portfolio,’ explains Kuczma. ‘Mexico may also thrive amid a desire by US and global companies to diversify their manufacturing away from Asia.

‘For US companies, this can help them move to a just-in-time inventory. Given the regional proximity, lead times into the US would be far quicker from Mexico. Importantly, there are also no concerns on intellectual property, unlike what might be the case with other emerging markets.

‘Additionally, Mexico would be a beneficiary from infrastructure spending in the US, which is an important part of the new stimulus package.’

Kuczma points out Latin America is exposed to the green energy revolution and says BlackRock Latin American owns a Chilean producer of lithium, one of the main raw materials used to make electric batteries.

UPSIDE FROM INDIA

India Capital Growth (ICG), currently trading at a 16.3% discount to NAV, is looking to take advantage of opportunities in the world’s second most populous country.

David Cornell, chief investment officer at India Capital’s manager Ocean Dial Asset Management, believes the recent budget unveiled by the Indian government sent ‘a very clear message that it is focused on growth. This comes as a welcome sign following five years of reform implementation, followed by a global pandemic, which saw earnings repeatedly disappoint.

‘Whilst Modi’s reform agenda caused short term pain, we expect the long term impact of these (Goods & Services Tax, Real Estate Regulations Act, Insolvency & Bankruptcy Code etc.) to feed into stronger, more sustainable growth, working hand-in-hand with the government’s plans to boost the economy.’

Even before the budget was announced, Cornell notes the IMF (International Monetary Fund) placed India as the fastest growing large economy for both full year 2022 and 2023 at 11.5% and 6.8% respectively in its GDP growth forecasts.

And according to Cornell, ‘the government’s change in stance from fiscal conservatism to growth-orientated comes at a crucial time.

‘The economy has largely re-opened following the stringent lockdowns implemented at the start of the pandemic, and this momentum needs to be sustained. Job creation will be key and should be supported by the increase in infrastructure spending as outlined in the budget.’

OTHER EMERGING MARKET OPPORTUNITIES

Trading at an 8.8% discount to NAV, a significant 29.5% of Templeton Emerging Markets’ portfolio is invested in China, Hong Kong and Macau, though this is less than the MSCI Emerging Markets index and the diversified trust also offers exposure to markets ranging from South Korea and Taiwan, to Brazil, India and Russia.

Sehgal says the pandemic has accelerated some long-term themes that have benefited Taiwan, which has a highly educated workforce that has been the backbone of its steady ascent up the value chain in manufacturing, whereby it is now an exporter of technology components and essential semiconductor chips that constitute the computing power behind modern technologies.

The trust also offers a play on South Korea through phones-to-semiconductors giant Samsung. ‘In addition, if we look at the Korean balance sheets at a sovereign level, Korea is one of the least leveraged major countries globally, with government debt to GDP less than 45%, compared to nearly 100% in the UK,’ adds Sehgal. ‘Korea is also a net oil importer, thus benefiting from the decline in prices, alongside the majority of emerging markets.’

Elsewhere, Henderson Far East Income’s (HFEL) manager Mike Kerley has been adding exposure to Korea, attracted by ‘a combination of attractive valuations, positive economic momentum and the possibility of more progressive dividend payouts’. Relevant stocks include added included financials KB and Shinhan and LG Corp.

SOUTH EAST ASIA EXCITES

Outside of North Asia, Kerley has added to Thailand by initiating on Thai Beverage, a stock that has ‘suffered from the lack of tourism spend on beer but has been supported by its spirits business which has been resilient from local spending and its Vietnam beer business which continues to grow rapidly’.

Another exciting market investors shouldn’t ignore is Vietnam, blessed with a young, upwardly mobile population of 97 million, forecast to grow GDP by 6.7% in 2021 and with a near-term MSCI upgrade from frontier to emerging market status offering a likely catalyst for money to flow into the Vietnamese equity market.

The pandemic has accelerated the longer-term migration of multi-nationals moving manufacturing from China to Vietnam, among them Apple, LG, Microsoft, Panasonic and Intel.

Many companies previous overreliance on China for their global supply chain, allied with cost advantages (according to specialist asset manager VinaCapital Vietnamese workers are 40% of the cost of Chinese), allied to a well-educated workforce with a strong work ethic has made the country an attractive location for manufacturing.

The government’s ongoing public spending initiatives also support the country’s attractiveness in terms of foreign direct investment. With construction and materials companies that supply infrastructure projects doing particularly well.

Emerging & Frontier markets

An emerging market is one that has some characteristics of a developed market yet doesn’t fully meet its standards. This includes markets that may become developed markets in the future or were in the past.

The term emerging market was originally coined in 1981 by then World Bank economist Antoine Van Agtmael and today encompasses markets that are typically growing much more rapidly than the developed world, have favourable demographics with youthful populations, are seeing technological innovation and also benefit from the expansion of the middle classes.

Risks include the potential for greater volatility, currency swings and often, political uncertainty. The term ‘frontier market’ is used for developing nations with smaller, risker or more illiquid markets than their larger emerging markets counterparts.

EASTERN PROMISE

Andrew Lister, Investment Manager of Aberdeen Emerging Markets (AEMC), is positive on the Russian market at present, seeing the ruble as undervalued and noting the country’s sovereign balance sheet is strong. ‘Equities are attractively valued, including some of the highest dividend yields in the asset class. Increased dividend payments are reflective of much improved governance in recent years.

‘Far from being an oil and gas proxy, the Russian market is home to many consumer and technology related companies now, and this is reflected in recent IPO activity. Politics is a perennial risk, but we believe valuations more than adequately reflect this. Russia is making encouraging progress on the rollout of its own Covid-19 vaccine.’

A fund looking to capture a potentially exciting emerging European story is Aubrey Global Emerging Markets Opportunities (BZ059L3), an investor in Polish grocery retailer Dino Polska, which Aubrey analyst Klyzza Lidman believes could be a Polish Walmart in the making.

‘Dino Polska’s store expansion plan supports our expectations of Dino Polska seeing 17% compound annual growth rate in earnings growth between 2020 and 2022, one of the highest growth rates in the EEMEA (Eastern Europe, Middle East and Africa) grocery retail sector,’ says Lidman.

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SHARES’ TOP EMERGING MARKETS PICKS

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JPMORGAN EMERGING MARKETS

140.6p

Premium to NAV – 0.27%

Adorned with a five-star rating by Morningstar, China may be JPMorgan Emerging Markets’ (JMG) largest regional allocation at 38.8%, but the portfolio is diversified across destinations ranging from India, Taiwan, Argentina and Brazil to South Africa and Indonesia and has delivered 10-year annualised share price and NAV returns of 11% and 9.9% respectively, versus 6.3% for the benchmark.

The majority of the portfolio is invested in software services, internet services, gaming, consumer brands and even stock exchanges, sectors where companies in the words of fund manager Austin Forey ‘do not have to invest large amounts of capital and therefore tend to generate higher returns on capital, require less leverage, and ultimately generate more cash for shareholders’.

Latin American holdings include MercadoLibre, the region’s leading e-commerce platform ‘with almost a third of the region’s entire population registered as users’, as well as software developer Globant, which provides its services to major western companies such as Disney, Google, LinkedIn and Coca Cola.

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MOBIUS INVESTMENT TRUST

114p 

Discount to NAV – 7.1%

Launched in 2018 by Mark Mobius and colleague Carlos von Hardenberg, Mobius Investment Trust (MMIT) seeks to deliver long term absolute returns by investing in dynamic small and mid-sized companies in emerging and frontier markets.

Besides India, Brazil, Russia and China, the trust is also invested in Turkey, Kenya, Egypt, Vietnam and Malaysia. During the year to November 2020, the trust’s NAV and share price rose 16.3% and 24.7% respectively on a total return basis.

The managers are finding attractive companies throughout the emerging and frontier markets universe. ‘Countries with the largest weights in our portfolio are India, Brazil, Korea, Taiwan and China,’ says Mobius. ‘All of these countries will profit from the expected recovery this year. India and China are expected to lead in terms of growth, but others will follow. We also continue to see outstanding innovation across Taiwan and Korea, particularly in the technology industry.’

Trading at a 7.1% discount to NAV, the trust focuses on resilient businesses which are undervalued and mis-priced and places heavy emphasis on engaging with portfolio companies to raise ESG standards, which helps to improve financial performance and catalyse re-ratings.

Holdings range from Indian software and digital services company Persistent Systems to Taiwan-based silicon intellectual property company eMemory, Turkish apparel company Mavi and Brazilian software company Totvs.

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VINACAPITAL VIETNAM OPPORTUNITY FUND

410P

Discount to NAV – 11.1%

While the discount on the VinaCapital Vietnam Opportunity Fund (VOF) has narrowed in from a 17.7% 12-month average to 11.1%, we see scope for strong risk-adjusted returns from its differentiated mix of listed and private investments in Vietnam.

The only one of its Vietnam trust peers to pay a dividend, an ongoing share buyback programme and continued strong performance should drive a further narrowing of the discount.

Vietnam’s strong response to the pandemic has limited the human impact on a country with comparative advantages including a young, well-educated population and relatively low labour costs. Vietnam turned out to be rare oasis of GDP growth in the economic desert of 2020 and according to the VOF team, is set fair to be the
next ‘Asian tiger’.

VOF’s listed holdings include steelmaker Hoa Phat, Airports Corporation of Vietnam and food and beverage business Vinamilk, while VOF is also the country’s largest private hospital investor. VOF has generated five and 10-year annualised net asset value (NAV) returns of 17.5% and 13.1% according to Morningstar.

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Lyxor MSCI Emerging Markets Ex China ETF

$25.14

A low-cost passive option to consider is the Lyxor MSCI Emerging Markets Ex China UCITS Exchange-Traded Fund (EMXC), which uses synthetic replication to track the benchmark
MSCI Emerging Markets ex China net return US dollar index.

The clue is in the name, as this index captures 25 of the 26 emerging markets as defined by MSCI, save for China of course.

Coming with a lowly total expense ratio (TER) of 0.29%, the ETF offers investors exposure to developing market leaders including Taiwan Semiconductor, Samsung, Naspers and Reliance Industries, as well as Vale, Infosys and SK Hynix.

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