Emerging economies were seen as one of the most promising markets for investors, yet they have struggled for a decade. However, their success in confronting Covid-19 could now put them back in the limelight and CAMRADATA’s latest whitepaper, Emerging Markets considers where the opportunities may lie as the world emerges from the pandemic.
The whitepaper includes insight from firms including Mackenzie Investments, Morgan Stanley Investment Management, PineBridge Investments, Aon, Broadstone, IMF, Law Debenture and Secor Asset Management, who attended a virtual roundtable hosted by CAMRADATA in September.
The report highlights that emerging markets have had less fiscal stimulus during Covid-19 yet ended up with better GDP. One prediction is that China’s economy will grow by 8.2% this year, compared to 1.9% in 2020. Meanwhile, the Eurozone is expected to grow 5.2% in 2021, after an 8.3% fall last year.
A key question raised in the report was whether improved economic fundamentals will help companies in emerging market regions generate higher earnings and boost their share prices, enabling them to get out of a decade of underperformance compared to developed markets.
Natasha Silva, Managing Director, Client Relations, CAMRADATA said, “Emerging markets have about 80% of the world’s population and 90% of the world’s expected growth over the next few decades. The familiar longer-term story of emerging markets is still intact, as factors such as the rise of the middle class and lifestyle upgrades play increasingly significant roles in these locations. Our whitepaper is a must read for those seeking to capitalise on potential growth in emerging markets.”
The discussion began with a snap poll amongst panellists of whether Emerging Markets (EM) prove a better risk-return profile than Developed Markets (DM). Half said yes. The panel then looked to define the ambit of Emerging Markets: whether they match a benchmark index or stretch wider; before exploring the nature of risk and return in Emerging Markets, and how to make the best of opportunities.
Other key discussion points included recommendations for avoiding too many downturns in emerging market economies, how the nature of emerging markets has changed, active vs passive strategies and currency volatility and risks. The panel closed with a discussion on Environmental, Social and Governance (ESG) issues.
Key takeaway points were:
- EM Investment Grade corporates had produced the best risk-adjusted return of any sector in global fixed income over the last 10 years. It was not a niche sector, either: representing over 15% of the global credit universe – bigger than US High Yield, for example.
- Other sectors of EM debt were two to three times more volatile than EM corporate IG, said one panellist who added asset owners and consultants need to be aware of this distinction when matching mandate requirements with risk tolerance.
- The share of issuance from Asia has risen dramatically to between 50- 60%, with 80-85% of issuance in this region bought by local and regional investors, who tend to have a ‘home market bias’, lowering overall volatility.
The same prevails in the Middle East but was not so much the case in Eastern Europe or Latin America, where in US$-denominated bonds, local pension funds as stable, and there are fewer long-term investors.
- One panellist said that investors need more Emerging Market equities than standard allocations suggest because of the higher alpha. Another said it was valuable to have an allocation to EM. There are different growth drivers, not a synchronised business cycle, which brings diversification.
- One such driver is population growth “even in China to 2050.” Another was the trading linkages between EM’s, which would develop with better infrastructure, boosting productivity gains greater than DM could muster
- A panellist said that local currency EM debt was much more volatile due to the underlying volatilities of local currencies. Adding that local currency volatility will often drown out underlying fixed income returns which means a lower risk-adjusted return metric for the asset class.
- Another said key in allocations within EM debt is to understand the different drivers in terms of rates, currencies and duration between corporates and sovereigns.
- Historically, ‘Quality Growth’ businesses have been cognisant of ESG issues. But an extra impetus now came from the young generation around the world “who really feel deeply about this topic.”
- One panellist said the importance of ESG criteria was changing through time. Governance used to play a critical role. Now the Environment plays the critical role. But they added that the Social is asserting itself more and has been for the last two to three years as a result of movements like ‘MeToo’ and ‘BlackLivesMatter’.
- The discussion ended with a warning from one panellist that if an investment management firm cannot articulate its ESG policy and process, then it will quickly become uncompetitive.
- They concluded that tackling the world’s biggest problems required an Emerging Markets focus. These countries produce 40% of global GDP but 68% of global CO2 emissions. EM corporations have the ability and importantly the financial incentive to become more sustainable. What matters is the difference in funding costs for the more sustainable players.