Diversified Thinking Through the Cycle
Emerging Markets: Growth at a Reasonable Price
Why emerging markets now?
Central banks and governments in developed markets continue to provide an unprecedented quantity of economic stimulus. Central banks are increasing global liquidity through the purchase of government and private sector debt while governments are increasing fiscal stimulus through job retention programs, extensions of unemployment benefits, tax cuts and provision of loan guarantees to the private sector.
Pledged monetary and fiscal stimulus has already significantly exceeded levels seen during the Global Financial Crisis while global interest rates have declined to unprecedented levels. History shows that the expansion of developed market central bank balance sheets has resulted in large capital inflows into emerging markets. Despite recent outflows during the outbreak of Covid-19, we expect there to be a recovery in flows across asset classes. Emerging market currencies have stabilised and experience suggests that emerging market equities perform well for sustained periods when global and local
bond markets rally.
The dollar has experienced a period of strong performance over the last 10 years and this move has been partially responsible for the US capital market outperformance. However, we believe that Covid-19 related stimulus and the resulting US fiscal deficits will be some of the factors that will likely lead to a weaker dollar over the medium term. Additionally, emerging market currencies remain competitive and attractively valued especially considering current account stabilisation as export market share remains well-supported. Low interest rates in the United States and an improvement in the global growth outlook will likely continue to put pressure on the dollar.
John Malloy and James Johnstone co-manage the RWC emerging and frontier markets team. The team is composed of a further 17 analysts, economists and strategists based in Miami, London and Singapore, many of whom have worked together for over twenty years. The team joined RWC Partners in 2015 and now manages c. $9bn for its clients. Emerging and frontier markets represent the fastest growing countries in the world. The RWC team believes the continued growth in these markets represents opportunities across a range of industries.The highly experienced and dedicated team takes an index-agnostic, opportunistic approach which allows it to explore investment opportunities that are often off the beaten track.
‘Emerging market economies remain key drivers of global growth and are on the
cusp of surpassing developed markets
from a nominal GDP standpoint’
Mobility and discretionary-related themes will likely take time to recover such as EM travel and tourism. However, many secular growth opportunities remain attractive in emerging and frontier markets. Technology disruption continues to be a key area of focus due to structural growth advantages such as lower penetration in fields such as smartphones, payments and food delivery. Moreover, we continue to see opportunities in the cloud and 5G spaces, mainly in North Asia. The recovery in commodity prices and the persistent electrification of the economy should be positive for holdings in our copper, sustainable energy and new auto technology themes.
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Chart 1: Nominal GDP should continue to rise as urbanisation levels continue to climb
Portfolio’s weighted 5-year compound annual earnings growth estimate
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While the outlook for emerging markets remains encouraging, there are various risks to our thesis. We have been monitoring Covid-19 closely and despite significant progress made in various emerging markets, the threat of a second wave and actions taken to prevent a further spread of the disease could affect the timing of a global economic recovery. The secular growth in the themes we outline is exciting. However, companies and sectors constantly evolve and there is a risk to our forecasted earnings if technology changes are rapid. Lastly, trade tensions and the upcoming United States Presidential Elections have the potential to disrupt investor sentiment towards emerging markets.
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Emerging markets have undergone a period of adjustment over the last few years. Factors such as trade negotiations, geopolitical tensions and the outbreak of Covid-19 have resulted in a deterioration in sentiment towards the asset class despite structural tailwinds. Emerging markets are home to c.85% of the world’s population with young and increasingly well-educated populations. Emerging market economies remain key drivers of global growth, possessing some of the world’s most innovative companies and are on the cusp of surpassing developed markets from a nominal GDP standpoint.
Nominal GDP should continue to rise as urbanisation levels continue to climb. Valuations are at attractive levels, especially relative to developed markets. Emerging markets remain under-owned and under-represented while company fundamentals are improving. We continue to monitor the full impact of Covid-19 and, in our view, emerging market economies are well-positioned to navigate current conditions. The stimulus provided by the authorities of both developed and emerging countries will likely result in a medium-term economic recovery and increased capital flows to the emerging world.
Chart 3: Unprecedented developed market stimulus should lead to increased capital flows for EM
As we have highlighted previously, emerging markets have young populations and higher average maximum temperatures which are helping some countries navigate the pandemic effectively. However, Covid-19 cases and deaths continue to rise in some countries. We continue to monitor the virus and its economic impact closely.
In North Asia, countries such as China, South Korea, Taiwan and Vietnam
dealt with the outbreak of the pandemic in a co-ordinated and comprehensive manner. India also implemented strict lockdown policies. While cases and deaths in continents such as Latin America continue to increase, mobility
is returning to emerging market economies suggesting a recovery in
Total deaths per million remain far higher in developed markets than in emerging markets so far. Undoubtedly, the main risk to our outlook for a recovery in global economic growth remains a reacceleration in infection rates globally and especially in countries that are struggling to contain Covid-19.
Chart 5: Total deaths per million are higher in developed markets than
in emerging markets
While Covid-19 will have a material impact on earnings for 2020, emerging market corporates have a significant growth gap relative to developed markets. Additionally, emerging market equities trade at a steep discount on a price to earnings and price to book basis. Balance sheets are also stronger in emerging markets than in most developed markets, excluding Japan.
On our estimates, the RWC Emerging Markets Equity Portfolio expects a weighted average return on equity of 15.8%, well above MSCI World and MSCI Emerging Markets, despite trading at a relatively lower 16x 2021 P/E. Furthermore, our weighted 5-year compound annual earnings growth estimate is 19.4%, compared to 12.5% for the MSCI Emerging Markets Index. Encouragingly, on a weighted average basis our portfolio holdings are net cash and have significant balance sheet stability.
Company fundamentals, valuations and performance
Chart 6: Emerging market equities are very attractive relative to bonds
Fundamentally, the outlook for emerging markets is encouraging. Unprecedented global stimulus, structural tailwinds, secular growth in various emerging themes in addition to attractive fundamentals and valuations show emerging market equities to be an attractive investment opportunity.
RWC EM Equity Portfolio weighted average return
Source: RWC Partners, Bloomberg, World Bank 2000 – 2050E
Source: RWC Partners, Bloomberg, World Bank 2000 – 2020E
Forecasts and estimates are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. The forecasts and estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so. The names shown above are for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice. No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment.
Source: RWC Partners, Bloomberg, Haver 2006 – 31 May 2020
Source: RWC Partners, Bloomberg, Refinitiv, Credit Suisse 1998 – 31 May 2020
Source: RWC Partners, ECDC, 25 May 2020
Source: RWC Partners, Bloomberg,
31 May 2020 (equity returns in $ terms)
Chart 2: This should lead to higher nominal GDP In emerging markets
Chart 4: Emerging market currencies are attractively valued compared to export market share
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