Emerging markets are expected to continue to grow at around twice the rate of developed economies in 2018, according to the World Bank. As activity among commodity exporters continues to recover amid firming prices, emerging market economies are projected to grow by 4.5 per cent in 2018. This is in comparison to growth in advanced economies moderating slightly to 2.2 per cent in 2018, as central banks gradually remove their post-crisis accommodation and the upturn in investment growth stabilises.
Emerging markets continue to provide strong investment opportunities and remain an important asset class for diversification in a portfolio. However, it is important that investors remember that not all emerging markets are on the same growth trajectory and they don’t all have a level playing field. It is also important to consider the correlation between the performance of emerging market stocks and the US dollar. When the US dollar strengthens the performance of many emerging markets is put under significant pressure. So, while growth in emerging markets is expected to be strong in 2018/19, investors need to look beyond just growth forecasts and get under the hood of industries, companies, and structural trends within emerging markets; to ensure they invest in high quality businesses at the best value.
Uncovering emerging opportunities
Asia continues to be the most attractive emerging region, with potential for strong growth in many industries such as financial services and e-commerce. The services sector remains underdeveloped, and there are companies with strong balance sheets and growth forecasts that can still be bought for an attractive price in some Asian markets. China and India will remain high performers within the region, and the search for emerging leaders and dynamic businesses within growth industries will uncover exciting investment opportunities.
For many emerging markets, growth will continue to come from developed industries such as manufacturing and commodity exporters. However, industries that are underdeveloped in these same emerging markets will drive growth and present high value for investors. For example, at least half of the Chinese economy continues to be based on a developed manufacturing sector, but new opportunities exist in financial services, consumer, technology, and healthcare.
Identifying the highest quality businesses in different industries and in different parts of the world will be the key to creating absolute returns for investors over the medium and long-term. To do so, it is important to uncover businesses that not only have strong balance sheets and growth potential at fair valuations, but a solid leadership team and a good company culture. In this way, emerging markets are no different to any other asset class.
Identifying the highest quality businesses in different industries and in different parts of the world will be the key to creating absolute returns for investors over the medium and long-term.
Financial services – high growth potential, high valuation
Financial services can generally be divided into two buckets:
- diversified financial services such as stock exchanges, fintech companies, and fund managers.
There is potential for significant growth in both areas in emerging markets. This growth will be underpinned by good structural trends, increasing income per capita and low levels of debt and credit penetration.
However, not all emerging markets are moving in lock-step. The financial services industry in India is significantly lagging China whose large population coupled with low credit penetration presents significant growth opportunities for banks. Similarly, Mexico, Brazil, and Russia could also experience significant growth within the financial services sector.
Despite these opportunities, valuations remain quite high in this sector and good things will come to those who can manage the right time to enter the market. Being cognisant of the economic and political landscape in each market can make a difference in investing in opportunities at fair value. For example, when economies are distressed, the best value in stocks can generally be found. This was the case in Russia and Brazil two years ago when their economies were deep in recession.
Consumer staples: The recession proof sector?
Consumer staples is an investment sector with major potential in the next year.
As emerging economies continue their upward swing, so too does consumer wealth within these markets. Increasing income per capita coupled with low penetration of many consumer products in these markets is providing exceptional opportunities for consumer staples businesses to expand market share. However, as in the financial services sector, stocks tend to trade at high valuations. Clever investors will look at consumer businesses listed in developed markets such as the United States that trade in emerging markets to capture opportunities.
A strong example of this is US-based Mondelez. It’s the world’s second largest confectionary maker and it owns brands like Cadbury, Oreo, Toblerone and Milka. These brands are sold all over the world with 35 per cent of their revenue coming from emerging markets. Cadbury only has a one per cent market share in the US, yet in India it is the number one chocolate brand with over 50 per cent market share. It’s a great company with considerable brand power and its growth potential remains strong on the back of new products like the Milka-Oreo chocolate bar.
E-commerce: Growth is just getting started
The whirlwind of e-commerce has caused widespread digital-disruption, but when you dig into the numbers, it appears this strong growth may just be getting started.
Globally, 90 per cent of retail sales still come from bricks and mortar stores, however the e-commerce sector is maturing and the shift towards it is happening most dramatically in some emerging markets. In China, 20 per cent of sales are online. Online retail is poised to see continued growth in the next five to ten years and e-commerce remains under penetrated world-wide. Online retailers like Vipshop, specialising in online discount sales, and Alibaba, a multinational B2B marketplace, continue to increase their customer bases and are growing at much faster rates than traditional retail in China.
Right place, right time, right value
Diversification of asset classes is important within any investment portfolio. Australia is but a drop in the investment ocean representing only 1.86 per cent of total world shares, so diversifying with global shares can literally open-up a world of possibility. However, creating diversification within a portfolio for the sake of it is not smart investing. Buying high quality businesses at a good value price should be the foundation for all investment portfolios.
Finding the right opportunity at the right price is a challenge in all markets and all sectors, but may be even more difficult to predict in emerging markets due to an array of factors including: lack of disclosure, changing labour environments, a volatile political landscape, and cultural and language barriers. Developing a deep understanding of businesses and the markets they operate in can build confidence to pick the right time and right value.
Whether investing in emerging or developing markets, understanding a business’ culture and assessing the capability of the executive team to run the business and deliver value to shareholders is just as important as doing the quantitative research into their past performance and future growth.