Are opportunities emerging in emerging markets?

Emerging market countries account for almost 80% of the world’s population, 60% of global GDP and the majority of its incremental growth*. They also have favourable demographics - younger populations that are likely to be at the forefront of internet-driven transformation within various industries.

But despite such a strong economic backdrop, their investment performance over the past decade has been somewhat mediocre. Emerging markets have returned 80.3% - roughly a third of the 226.9% returns posted by developed markets**.

Aikya Investment Management points out that emerging markets are called emerging for a reason. While the promise of future growth is attractive, these markets suffer from various macroeconomic vulnerabilities, governance challenges and weak institutional structures.

Their economies also tend to be more reliant on the manufacturing and resources sectors, which make them inherently more cyclical when compared to developed market economies that are more driven by domestically orientated services.

But does that cyclicality mean that emerging markets are poised to benefit from the world re-opening?

Changing fortunes?

Nick Price, fund manager at Fidelity, commented: “Emerging markets have evolved, but commodities continue to play an important role in many of those economies. Supply constraints are now joined by huge stimulus and a transition to a cleaner, greener economy, driving demand up and lending support to commodity prices.

“Emerging markets continue to trade at a wide price-to-book discount to developed markets, and investor positioning is light, suggesting there may be less risk of a large correction if the optimism over vaccination programmes proves premature. As the market starts to consider a more reflationary backdrop and commodity demand rises further, ‘cheaper’, more cyclical emerging stocks are likely to benefit, particularly those in emerging Europe and Latin America.”

Indeed, Central European markets were some of the strongest performers across emerging markets in May, according to Barings, with Hungary (16.0%), Poland (13.7%) and the Czech Republic (10.6%) all posting double-digit returns. Russia equities also rose 9.5%, supported by rising oil prices and a strengthening ruble***. 

Latin American equities also rallied in May, ending the period as the strongest performing region across emerging markets. Peru (10.5%) was one of the best performers, followed closely by Brazil (9.6%), where rising commodity prices and an improving global growth outlook helped boost equity markets***.

But what are the risks?

As previously stated, emerging markets can be volatile. Rising inflation is another key risk (and the potential for rising interest rates) and it has accelerated in the US in recent months. But the team at Alquity believe it is quite unlikely that the currency spike will force the US central bank to make an abrupt U-turn on its policy commitments. “Ultra-loose monetary conditions in the US should persist for years – even after the start of tapering – supporting the appetite for riskier assets – of which emerging markets will be a prime beneficiary,” they said.

“The favourable tailwinds for emerging markets have only strengthened in recent months – both from a global and a regional perspective. For the first time in a while, there is a strong investment case for all parts of emerging markets– Asia, India and the commodity dependent areas of Latin America, Middle East and Africa.”

Five funds for emerging markets

Investors thinking of allocating money to emerging markets could consider the following funds:

1. Aubrey Global Emerging Markets Opportunities

On the Chelsea Selection, preferred areas of investment for this fund include the travel, education, healthcare and e-commerce sectors, and there is a focus on firms which either have dominant or first-mover advantage.

2. RWC Global Emerging Markets

The manager of this Core Selection fund analyses the economic and political backdrop before looking for companies trading on reasonable valuations but tapped into key long-term themes or trends.

3. FSSA Global Emerging Markets Focus

This fund invests in 40-45 large and medium-sized firms. The manager has an absolute return mindset and looks for quality companies that can demonstrate sustained and predictable growth over the long-term.

4. Magna Emerging Markets Dividend

This fund offers exposure to emerging market companies that pay higher-than-average dividends. This results in a slightly lower risk profile than peers and an attractive yield, which may appeal to income investors.

5. Federated Hermes Emerging Markets SMID Equity

The small and mid-cap opportunities in emerging markets are enormous, but also carry significant risk. The comprehensive process of this fund helps to manage the potential pitfalls.

*Source: Aikya research

**Source: FE fundinfo, total returns in sterling to 17 June 2021

***Source: Barings, Factset. as of May 31, 2021. Returns based on MSCI regional and country indexes in USD.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the spokespeople and author and do not constitute financial advice.