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Three things the Franklin Templeton Emerging Markets Equity team are thinking about today

1. As we examine the emerging market (EM) landscape today, the rise of leverage within economies is a key trend. Leverage can be a double-edged sword, as it can be positive, but also represents a source of risk. Over the past decade, the level of debt has gone up not just in EMs, but across the world. Covid-19 has certainly led to a dramatic increase in government debt in some countries but, in general, debt to gross domestic product is currently much lower in emerging economies than in developed countries—which is one reason for our bullish view. Aside from an increase in China, corporate debt as well as household (consumer) debt levels in EMs also remain much lower than in the developed world. As such, we feel that EMs have much more headroom available to support growth with increased debt levels without a significantly detrimental impact.

2. Cash flows are one of the reasons we remain positive on EMs. In the last decade, EMs have underperformed the developed world in terms of return on equity. But over the last decade there has been a trend of improving free cash flows (in both absolute terms and relative to developed markets) that has indeed accelerated in the last year. EM companies are generating much more free cash this year because both commodity-oriented and technology-oriented companies (in particular, the semiconductor industry) have been doing well. As cash flows increase, we believe this will ultimately result in improved returns on equity for EM stocks and should likely propel a rerating.

3. EM companies have been preparing for climate change in multiple ways. Some are seeking to meaningfully decarbonize in high-emitting sectors, while others are providing environmental solutions through their products and services. Against this backdrop, our objective to understand the climate commitments of our investee companies incorporates both local and global perspectives. Our investment process incorporates top-down policy and industry studies, bottom-up company research, and comprehensive environmental, social, and governance analysis including climate considerations.

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