Time to re-think emerging markets investments?
THE pandemic is making us re-think many important aspects of our lives and this should include our investment thinking.
One such area worth a fresh look is emerging markets (EM). We have seen incredible growth here over the last few decades and while EM countries have been impacted by Covid, investors are currently looking beyond the pandemic. From September until the end of last year, we saw week-on-week inflows into EM equities and bonds.
The term ‘emerging markets' was coined in 1981 by Antoine Van Agtmael of the World Bank to define a country with low to middle per capita income and depending on the degree of development of their financial markets. In the intervening 40 years since then, the economic and investment landscape has changed significantly.
A key factor has been the change in the sector weighting within the index we use to track the performance of this group. When the EM Index was launched, over half of the assets were commodity and materials, whereas in 2021, materials now account for just 7 per cent and technology, which was just 7 per cent in 1988, now makes up 20 per cent. Interestingly, the top names in the index are now big, recognisable Chinese and Asian technology names such as Alibaba, Tencent, Taiwan Semiconductor and Samsung.
So what are the trends investors should be watching to keep in tune with the EM landscape?
The first trend is technology and China is really nailing the acceleration of this at the moment. China's goal of building a self-reliant technology industry has been elevated to become a strategic pillar. As part of the response to the pandemic, China has launched an infrastructure programme, with much of the investment going into ‘new infrastructure', such as green energy, 5G networks, big data centres, and electric vehicle charging stations.
In addition to technology, the other big trend in 2020 has been ESG (environmental, social and governance) investing. Increasingly aware investors are demanding additional scrutiny, both in terms of the role and social value of companies in society and how they are managed.
Take for example South Korean shares, which historically have not enjoyed much respect from investors due to the nation's governance and ownership structures. Alert to this, South Korea has introduced new legislation aimed at limiting major shareholder powers, with demonstrably tighter governance regulations to improve internal controls. We'll be watching to see if this makes South Korean companies more investor friendly.
Meanwhile in Brazil, the spotlight has been on environmental issues, following the recent Amazon fires, causing investor alarm. In response, the Brazilian stock exchange has developed a Corporate Sustainability Index to measure the average stock performance of companies adopting sustainable policies. There is now a far greater awareness among Brazilian businesses of the need to adhere to environmental criteria, especially for those seeking to raise debt and equity internationally.
There remains a longer-term question of the opportunities in EM companies and in particular how they are represented in global stock markets. While emerging countries account for more than 58 per cent of the world's economic output, their stock markets are worth, in aggregate, only 12 per cent of the Morgan Stanley All Country World Index (MSCI ACWI).
The obvious attraction at the minute is China, where we are seeing a more advanced recovery, but access to investment opportunities there is not without issue. The Chinese government has a majority holding in many businesses (State Owned Enterprises) which are also listed on the Chinese stock market to allow them to raise funds. Investors should consider whether they prefer companies which are part-owned by the government or privately-owned companies, which will be run to maximise shareholder returns?
In conclusion on EM, investors should consider the allocation in their portfolio – does it reflect the opportunities available?
A mixed portfolio should include allocations to both emerging market equity and bond markets where there are opportunities. Given the wide and varied asset class and the issues highlighted here, investors should seek out active, knowledgeable managers who can allocate capital to those companies with the greatest opportunity set and avoid companies where the governance and objectives do not align with shareholders' values.
:: Cahir Gilheaney is a wealth & investments manager with Barclays Wealth & Investment Management team in Belfast.