It's time to reset expectations for emerging market equities. For more than a quarter of a century, investors have seen a transformational growth in the economies of emerging market countries. But times have been tough recently, with an increasingly stark divergence in returns with several developed economies, in particular the US.
As many emerging market economies ostensibly undergo wholesale industrial revolutions, they are now encountering the various problems associated with rapid growth and the move up the value chain beyond mere commodity manufacturing. At the same time, significant political, social (and in some cases, ideological) upheavals have all been adding to the complexity that emerging market companies currently operate in; this inevitably has a direct effect on the predictability of corporate earnings streams and investors’ abilities to identify sustainable business models.
In an asset class that inherently benefits from a broad fundamental analysis and a long-term view, there is perhaps now an even greater requirement to understand the positioning of individual businesses in the wider context of emerging market change and evolution.
There are five main factors that are currently providing the key backdrop for company performance and having a direct impact on investment outcomes in the emerging market universe:
1 Domestic politics
The standout positive result from last year was the election of Narendra Modi in India on a platform of reform and economic growth revival. The early signs are very positive and investor expectations are high.
The election of reform-minded candidate Joko Widodo in Indonesia was also particularly well received by the markets, on the expectation that planned reforms would boost that economy. However, since the election, investor confidence has been shaken. Widodo faces major political barriers in his attempts to push through his development programme and there is evidence of unexpected government interference in market pricing.
The presidential elections in Brazil were among the most important for the asset class. In spite of an apparent strong voter base, the incumbent Dilma Roussef won by only a narrow margin. Investors have low expectations here, but the outside prospect of greater fiscal discipline and growth-enhancing measures mean it could be the 'wild card' among the larger emerging markets.
Reforms are absolutely essential for the vast majority of emerging markets - they are a prerequisite for far-reaching policies that will restructure and energise economies. China will continue to dominate many of the headlines in this respect, with investors focusing on the ongoing reform of state-owned enterprises, Chinese banks, currency management and the continued success of 'new economy' business models.
3 Geopolitical conflict
The gradual increase in national confidence gained by the new generation of leaders in the fast-growing economies of the asset class has inevitably resulted in national assertiveness, demonstrated in more robust trade diplomacy and defiance over long-standing and unresolved territorial disputes.
'Clean' resolutions for many of the conflicts we're facing today are unlikely, and as a result, higher cost of equity looks like it is here to stay.
4 Currency wars
Competitive devaluing of currencies is likely to remain a tempting tool for nationally assertive emerging market governments. For the majority of cases, this will imply higher currency volatility and more expensive hedging, which could make cross-border trade and M&A activity more expensive.
5 Domestic power struggles
Domestic power struggles are endemic in many emerging market countries, but have become more significant as burgeoning middle classes accelerate changes to established political and social structures. It is extremely difficult for businesses to remain truly 'neutral' in these battlegrounds and as a result, understanding complex 'country factors' have become increasingly important in investor decisions. At the company level it is therefore even more important now to consider the impact of these shifting social and governance factors.
We are witnessing a secular shift in the emerging market economic power structures, with all the risk and opportunities that this entails, but the long-term prospects for the asset class are positive. Valuations for emerging markets have fallen to much more acceptable levels, compared with virtually any time since the global financial crisis, and the range across the asset class is diverse. It's a brave new world for emerging market equities, and one that requires an adapting investor insight.
For further information on emerging markets and to read Martin Currie’s new Active Insight publication, click here.
Martin Currie is an active equity specialist and part of Legg Mason.
The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person. Legg Mason Asset Management Australia Limited (ABN 76 004 835 849 AFSL 240827) does not guarantee any rate of return or the return of capital invested. Past performance is not necessarily indicative of future performance. Investments are subject to risks, including, but not limited to, possible delays in payments and loss of income or capital invested. These opinions are subject to change without notice and do not constitute investment advice or recommendations.
Martin Currie Investment Management Limited, registered in Scotland (no SC066107) Martin Currie Inc, incorporated in New York and having a UK branch registered in Scotland (no SF000300), Saltire Court, 20 Castle Terrace, Edinburgh EH1 2ES. Tel: (44) 131 229 5252 Fax: (44) 131 222 2532 www.martincurrie.com. Both companies are authorised and regulated by the Financial Conduct Authority. Martin Currie Inc, 1350 Avenue of the Americas, Suite 3010, New York, NY 10019 is also registered with the Securities Exchange Commission. Please note that calls to the above numbers may be recorded. This information is issued and approved by Martin Currie Investment Management Limited ('MCIM'). It does not constitute investment advice or represent an inducement to invest. Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested. Past performance is not a guide to future returns. The document may not be distributed to third parties and is intended only for the recipient. The document does not for the basis of, nor should it be relied upon in connection with, any subsequent contract or agreement. It does not constitute and may not be used for the purpose of an offer or invitation to subscribe for or otherwise acquire shares in any of the products mentioned. The information contained has been complied with considerable care to ensure its accuracy. However, no representation or warranty, express or implied, is made to its accuracy or completeness. Martin Currie has procured any research or analysis contained in this presentation for its own use. It is provided to you only incidentally and any opinions expressed are subject to change without notice. The opinions contained in this document are those of the named manager(s). They may not necessarily represent the views of other Martin Currie managers, strategies or funds. Investors should also be aware of the following risk factors which may be applicable to the strategies shown in this document. Investing in foreign markets introduces a risk where adverse movements in currency exchange rates could result in a decrease in the value of your investment. Emerging markets or less developed countries may face more political, economic or structural challenges than developed countries. Accordingly, investment in emerging markets is generally characterised by higher levels of risk than investment in fully developed markets.