Why China woes shouldn’t deter investors from attractive and evolving Emerging Markets

China’s sluggish recovery has been a major disappointment for investors this year, but other emerging markets have been growing fast. For example, the likes of India and Latin America have been among the top performing markets this year*.

Many countries in emerging markets are benefiting from high economic growth, favourable demographics and a growing consumer, creating real opportunities for agile fund managers.

China’s weakness

The World Bank has cut its forecast for China’s growth in 2024** and warned that the country’s economic weakness could drag the wider region to its worst growth in half a century. Given this damning verdict, investors may be tempted to swerve emerging markets altogether, but in reality, there is a lot to like in the world’s developing nations.

Certainly, some parts of the emerging market recovery haven’t quite gone to plan. At the start of 2023, it looked like China’s reopening after Covid would galvanise growth across Asia. The Dollar seemed set to weaken as the US reached the end of its rate rising cycle; traditionally a good signal for emerging markets.

As it is, China’s recovery has been feeble, with consumer confidence failing to revive. US economic growth has surprised with its vigour, meaning interest rates have gone higher, and now look set to stay that way for longer. This has kept the Dollar high. Sentiment has continued to weaken and the Investment Association China/Greater China sector is the weakest-performing sector for the year to date.

Beyond China

However, China’s problems should not obscure the other exciting things happening in emerging markets. Latin America and India have been two of the top performing sectors for the year to date*. In Latin America, a number of countries have been the first in the world to cut interest rates, including Brazil, Chile and Peru***. These countries raised rates long before the Federal Reserve and have reaped the benefits in terms of lower inflation. They still have ample room to cut rates further and this should help drive their economies from here.
India has also been going from strength to strength. In June, Indian Prime Minister Narendra Modi touched down in Washington for his first state visit to the US, a sign of India’s growing economic and political might. The country is drawing in capital from abroad, with international companies building manufacturing there. The IMF is predicting GDP growth of 6.1% for 2023****.

Other countries are also seeing exciting growth. Indonesia, for example, has harnessed its commodities boom, delivered strong economic management and a thoughtful industrial strategy to become an economic powerhouse. The country grew its economy by 5.3% in 2022^. There are also beneficiaries of China’s weakness. The “China plus one” strategy – whereby global companies look to diversify manufacturing away from China – is already benefitting companies in Vietnam and India.

Beyond commodities

Equally, the opportunity set in emerging markets has broadened considerably. They have also come a long way from just focusing on ‘BBC’ – banking, brewing and cement – the traditional staples of emerging market economies. Today, they are home to some of the most exciting technology and consumer companies in the world. Mercado Libre, for example, is the largest e-commerce player in Latin America^^, while JD.com is its equivalent in China^^^. Both can take advantage of a thriving middle class with increasingly deep pockets.

Taiwan-listed semiconductor manufacturer TSMC can lay claim to be one of the most important companies in the world and is a major holding for many emerging market funds. Governments across the world are scrambling to catch up with its intellectual property (without significant success so far). Increasingly, emerging markets are home to world-leading technological innovation.

Valuations

Valuations remain cheap relative to their developed market peers. Using the p/e ratio – a measure of how much an investor has to pay for every pound of earnings they receive – emerging markets trade on an approximate 30% discount to their developed market peers^^^^. In general, they are growing more quickly and do not have some of the constraints of developed markets, such as high inflation and debt.

No active manager needs to hold China unless they want to. Emerging markets offer a vast smorgasbord of opportunities outside China and a good active manager can dig into those areas. The Federated Hermes Global Emerging Markets SMID Equity, for example, has just 15% in China*^, with its portfolio concentrated in India, Taiwan, and South Korea. Another Chelsea pick, GQG Partners Emerging Markets Equity, has just 16% in China**^, and is focused on areas of technological innovation across emerging markets.

For those willing to take more risk and look long-term, the GS India Equity Portfolio may be an option. Indian markets have had a strong run and valuations are relatively high, but it is undoubtedly a country going places with a strong track record of innovation. This active fund provides exposure to a selected portfolio of opportunities.

There is no need to swerve emerging markets just because China is going through a rough patch – opportunities in emerging markets are idiosyncratic and not all emerging markets will be firing at once. There are plenty of growth opportunities for active, agile managers.

*Source: FE fundinfo, total returns Sterling 30 Dec 2022 to 3 Oct 2023
**Source: The economic times, 2 Oct 2023
***Source: Financial Times, 3 August 2023
****Source: IMF, July 2023 World Economic Outlook
^Source: IMF Executive Board Concludes 2023 Article IV Consultation with Indonesia, 25 June 2023
^^Source: Nocnoc, 7 July 2023
^^^Source: JD.com
^^^^Source: MSCI Emerging Markets Index, 31 August 2023
*^Source: fund factsheet, 31 August 2023
**^Source: Fund factsheet, 31 July 2023

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 author and fund managers and do not constitute financial advice.