As we enter 2022 we can expect robust fundamentals to serve as a key tailwind for emerging markets (EMs).
From a top-down perspective, regulation noise in China, ongoing Covid concerns, geopolitical risk and
inflationary pressures have all weighed on sentiment. However, we remain excited by the opportunities we see
across the asset class.
In China, we are witnessing a regulatory cycle which started
in the back end of 2020. We can expect this to continue
into elections next year with the government focusing on the
notion of common prosperity. We believe dismantling the
private sector is not the objective and many of the policies
are, in fact, on the “wish lists” of Western economies – for
example, data privacy and curbing monopolistic practices.
We are focusing on areas of the economy with policy
tailwinds that will benefit from the government’s prosperity
and productivity agenda – such as “Made in China 2025” –
in everything from the semiconductor industry to biotech
and electric vehicles to name a few. We believe we are out
of the first phase of regulation where equity risk premium
from domestic regulation feels priced in, and are moving to
the next phase where regulatory rules get applied. There are
also signs of policy easing as we move into an election year,
however we can expect normalised policy as opposed to
large stimulus.
In terms of US-China relations, we can expect the Biden
administration’s stance to remain unchanged given the
bipartisan support in Washington for its policy towards Beijing, with the administration also likely to have the support of allied
countries. We are also monitoring the optionality around US-China trade
tariffs, as US Treasury Secretary, Janet Yellen, explores relaxing Trump-era
tariffs to help ease some inflationary pressure.
Although vaccine optimism has fuelled positive investor sentiment
globally, we still envisage distribution challenges in the near term.
We are continuing to monitor the scale of new infection waves globally
while considering the risk of new variants. Meanwhile, the outlook for
inflation remains a key issue for both emerging and developed markets, as
central banks may begin to moderate monetary policy accommodation.
It’s fair to say that concerns over the US Federal Reserve tapering still
have an impact on sentiment related to emerging economies. In 2013,
the “fragile five” were identified as most at risk due in part to their large
current account deficits. This still weighs on investors to some degree.
However, the notion of the “fragile five” is no more, it seems to be just
Turkey which is vulnerable. Even if we exclude China, which has a large
current account surplus, in aggregate emerging economies are in a current
account surplus. This doesn’t mean the market won’t react to concerns
over Fed tapering and ask questions later, but when they do ask questions
they will get much better answers than in the past. From an investment
perspective we will use the sentimental market reaction as an opportunity
to add to specific companies which we like long term.
EMs are breaking away from their dependence on the developed world,
with heightened domestic demand increasing resilience to external forces,
the development of local debt markets and the stabilisation of the interest
rate differential between the US and emerging economies. Therefore, we
don’t have the same weakness in different pain points.
We also place a lot of importance on ESG (environmental, social and
governance) characteristics, which will no doubt become yet more
important throughout 2022. Understanding how well a company manages
its material ESG risks is key to assessing the quality of an investment.
The focus of our ESG research approach is to understand exposure
to, and management of, factors which have an impact on performance
through regulation, physical threats to assets, brand and reputation,
and operational costs. We follow a best-in-class approach and assess
companies against peers.
More broadly, we believe the key long-term trend for EMs is the transition
from predominantly export-led growth to reliance on buoyant domestic
demand. This is reflected in the change of composition of the universe,
which is now dominated by higher quality structural growth companies with
a domestic focus. In 2008 more than 60% of the universe was exposed to
cyclical growth; today around 60% of the universe is exposed to structural
growth. Furthermore, there has been nearly a 90% increase in the number
of companies coming to the market in the past decade. We believe the
innovation of the universe, in both depth and quality, is ideal for stock
pickers and is where we can add value in active management. Investors
should now be looking at EMs through a different lens.
Structural wealth creation, a rising middle class and the associated
changes to consumption and services is the dominant theme for us.
This leads us to various trends, including: the technological revolution,
with the emergence of platform companies with various verticals (the
adoption of technology in general usually happens faster in EMs because
infrastructure isn’t as well developed so it’s easier to start using
e-commerce); financial penetration, where we’re seeing both an increase
in traditional participation and inclusion, as well as fintech developments;
and localisation, with many countries focussed on creating strong
domestic brands and developing domestic industries.
