Have emerging markets passed the Covid test?

We examine how emerging markets are becoming an increasingly mainstream choice for investors.

Emerging markets illustration

We are now just a little over one year on from the start of the global Covid-19 pandemic and sometimes it seems like one country keeps hogging the investment media headlines – the US stock market and its collection of retail-friendly tech stocks.

But dig around in numbers from the big benchmark index firms such as S&P Dow Jones and another story emerges. If we look at 12-month returns from March 2021, the biggest gains have been from investing in India (up 83%), Taiwan (also 83%) and South Africa (up 79%). The US is by far and away the best developed world market with a return of 60%, but it’s only just a smidgeon ahead of Mexico, its neighbour to the south (up 58%).

Overall if we group all developed world countries, one-year returns have averaged 55% whereas all emerging markets are only a bit behind at 53.8%. If the pandemic was a test of Emerging Markets (EM) then it’s safe to assert that many emerging markets, especially in Asia have passed that test. But one year of admittedly volatile numbers should never be the only way of judging asset classes viability.

For a longer-term perspective, it’s worth digging into the historical data, much of which can be found in this year’s version of the Credit Suisse Global Investment Returns Yearbook, written by academics Elroy Dimson, Paul Marsh and Mike Staunton. They have built a comprehensive long-term database of all global EM and developed market (DM) stocks and have found that since the 1960s EM equities have outperformed DM equities by an average of 1.5% per annum. On a nation-by-nation level stocks in Taiwan, Hong Kong and South Korea have produced ‘outstanding’ returns.

EM vs DM returns

For instance, stocks in Taiwan, Hong Kong, South Korea, Russia and even Mexico have returned an annualised 8% real gain over many decades, while if we look at returns relative to developed markets indices Taiwan has produced a 4% annualised additional real return with Hong Kong not far behind at 3.8% and South Korea at 3.6%. But here’s the interesting reveal – these academics have also found those extra returns were not necessarily derived from taking on lots of extra risk. In fact, their data suggests that a diversified portfolio of EM equities are now broadly on par with developed markets.

The academics report in the Yearbook that “over the most recent five-year period, the annualised volatility of a diversified portfolio of EM equities – as represented by the MSCI EM index – is just 17.6%. This is only slightly above that of a diversified portfolio of developed markets (15.1%) as represented by the MSCI World index”. Unsurprisingly the authors conclude that “emerging markets are now mainstream investments with a key role in global portfolios. Their importance will continue to rise”.

The driver behind that growth is not hard to discern. Asia in particular, but also Latin America and Africa to varying degrees, are undergoing concurrent waves of modernisation and urbanisation, powered in turn by globalisation and technological disruption – the main impact of which is felt on the ground in the growth of a huge global EM middle class of consumers. The McKinsey Global Institute puts it succinctly when it says that “by 2025, annual consumption in emerging markets will reach $30 trillion – the biggest growth opportunity in the history of capitalism”. 

Dig around inside the portfolios of many leading EM focused investment trusts such as Templeton Emerging Markets or TEMIT and you won’t be surprised to discover a long list of consumer and consumer tech businesses such as Taiwan Semiconductors, Samsung, Tencent and LG Corporation. Even a more ‘traditional’ sector such as banking – Indian bank Icici is a top ten holding in TEMIT – can be regarded as a focused play on the growing middle-class consumer dynamic.

Finding an EM specialist

Yet despite these optimistic numbers, it's always best to tread with some caution moving forward. The many academic studies of emerging markets constantly emphasise the need for a diversified mix of nations and sectors, with not too much focus on just one momentum driven market – active managers are ideally positioned to carefully move back and forth between countries. And that is doubly true as the markets embrace the move towards sustainability and ESG based investing – working out which businesses and sectors have a more robust long term business model almost certainly requires a more active approach to stock selection, one which specialists such as TEMIT have been developing for many years now as part of the ESG analysis framework.

And although a giant macro trend like EM consumer technology can be captivating, active fund managers are also alive to ‘traditional’ sectors which can also drive returns. That is easy to see in the last few weeks where we’ve seen some subtle twists and turns in emerging markets. According to recent research from analysts at emerging markets bank Renaissance Capital, until mid-February, tech-heavy China and Taiwan were making all the running. Since then, they report, a combination of oil/commodity exporter led countries as well as those with pegged currencies or relatively low macro risk (Saudi Arabia, Chile, Kuwait, Russia, UAE) or strong trade links to the US (Mexico) has been outperforming.

At this point it’s worth reminding investors of the acronym BRIC which has become less widely used in recent years – it stood for Brazil, Russia, India as well as the leviathan that is China. India and China may have done very well in the first phase of the pandemic but in recent weeks some key Asian markets have suffered big losses while Russia has outperformed despite sanctions fears.

Many strategists now speculate that with the US economy looking like it might be roaring back in Q3 and US government bond yields rising again, what are called growth-sensitive countries and sectors (commodities, financials and real estate) might start to overtake 2020 winners. But even if these predictions do not quite pan out as expected, the central point stands. Emerging markets are increasingly a mainstream choice, with many offering the potential for above average returns with little added risk. Yet navigating between these diverse markets and sectors increasingly requires active fund management.

Learn more about investing in emerging markets with the Templeton Emerging Markets Investment Trust (TEMIT)

Recommended

The bulls return to emerging markets
Emerging markets

The bulls return to emerging markets

Last month, the MSCI Emerging Markets index outperformed developed markets for the first time since January.
11 Jun 2021
Emerging markets fall behind their developed-world counterparts
Emerging markets

Emerging markets fall behind their developed-world counterparts

While developed-world markets look forward to a recovery, emerging market stocks have tumbled as foreign investors pull out cash.
16 Apr 2021
Four of the best investment trusts for investing in emerging markets
Investment trusts

Four of the best investment trusts for investing in emerging markets

Investors need to tread very carefully in this risky sector. Here are the best ways to approach it
22 Mar 2021
Storm brews in emerging markets as investors pull cash out
Emerging markets

Storm brews in emerging markets as investors pull cash out

Foreign investors have begun to pull cash out of emerging markets as they begin to look less attractive when compared to the rising return from holdin…
12 Mar 2021

Most Popular

The real problem of Universal Basic Income (UBI)
US Economy

The real problem of Universal Basic Income (UBI)

April employment numbers showed 75 per cent fewer people in the US returned to employment compared to expectations. Merryn Somerset-Webb explains how …
1 Jun 2021
The biggest threat to crypto comes from stablecoins
Bitcoin & crypto

The biggest threat to crypto comes from stablecoins

Governments are increasingly getting worried about "stablecoins", cryptocurrencies which have a more "stable value". John Stepek explains what stablec…
3 Jun 2021
Why it might be better to delay saving for your retirement
Pensions

Why it might be better to delay saving for your retirement

We are advised to put aside as much as we can as early as possible. But is that always sensible?
8 Jun 2021