Many investors avoid investing in emerging markets for this simple reason: It often feels safer to invest in what you know at home, rather than the unknown abroad.
For a long time this assumption seemed true, with emerging markets whipsawed by major local events like the Asian currency crisis, or globally by a surge in oil prices or a sudden run-up in the U.S. dollar.
But do these concerns overshadow changes in emerging markets that suggest investors need to reassess how they view these markets? Certainly, many emerging market countries now have governance and regulatory regimes that are equal to western countries, and with companies as sound as any business in Canada or the U.S.
Sun Life Global Investments recently purchased Excel Funds. Christine Tan, who was Excel’s CIO and is now Assistant Vice President, Portfolio Management, at Sun Life Global Investments, says advisors should take a harder look at emerging markets, which she believes are relatively safe places to invest and have many strong and stable businesses.
Explains Tan: “Many of the companies in these countries are as stable as any developed-country business, but they are growing at a faster clip.”
Tan notes that today there is strength across most sectors in emerging markets, including banking, telecom, consumer staples and technology.
She holds up Chinese tech giant Tencent Holdings Ltd. as an example, noting that the 20-year-old company has a market capitalization of US$460 billion. It has strong management, which includes executives who went to school in the U.S. and worked in Silicon Valley – the heart of the U.S. tech industry.
“These companies have strong corporate governance. Some are listed in the U.S. and follow U.S. filing and disclosure requirements,” Tan says.
As China’s economy continues to expand at an almost 8% annual rate, these companies are growing faster than their developed-market rivals, which potentially gives them an edge in the race for market share over their North American and European peers. “What’s interesting is that, despite their size, they’re still growing very quickly,” says Tan, “because their home market demographics are so young and the penetration of goods or services is still very low.”
India is another country that has seen rapid growth in recent years. For example, the country’s Yes Bank has seen revenues surge by 30% annually to the end of 2017, which is much faster than its Canadian peers, even though it’s far bigger than our domestic banks.
In just 14 years, Yes Bank has grown to become the fourth-largest private sector bank and one of the top five most profitable banks in the country. Like many emerging market companies, the bank’s rapid growth stems from an improved regulatory environment, technological innovation and structural changes in the economy, says Rana Kapoor, managing director and chief executive officer of Yes Bank.
India’s middle class continues to grow, with 380 million people expected to move into this class by 2030, according to the Brookings Institute. As a result, a broad range of sectors, such as financial services, telecom, automotive and pharmaceuticals, have seen explosive growth. So it’s hardly surprising that some of India’s private banks and financial companies are growing by as much as 30% annually and generating more than a 20% return on equity.
China is experiencing similar growth and is expected to add an additional 350 million people into its middle class over the next 12 years. Smaller, emerging market countries like the Philippines and Indonesia are also growing rapidly. Indeed, Indonesia’s population is nearly as big as that of the U.S., but Tan notes that it has a much younger demographic with lower, but growing, income levels. “Imagine where they will be over the next decade,” she says.
One of the reasons emerging markets have been volatile in the past is reliance on the U.S. and other developed counties as an export market. This means, for example, if the U.S. went into recession, it would have a decidedly negative effect on these countries. But now, with their economies bolstered by a growing middle class and rising domestic consumer spending, they are better able to withstand shifts in the global economy.
A growing emerging middle class, more progressive policies and increased government spending on infrastructure have improved the resiliency of these emerging market countries.
But advisors have to be aware that as emerging market companies get larger and emerging market economies mature, rapid gains in stock prices could be tempered. Explains Tan: “Emerging market volatility has declined, which comes as part of the maturing of the asset class, so overall returns will be more moderate now on an annual basis.”
However, for now, emerging markets are still growing at a significantly faster pace than developed markets. And with lower levels of volatility, it may translate into better risk-adjusted returns over time.
“That’s why investors should view emerging markets as a more strategic allocation,” she says. “If you’re young and you donʼt need your capital for 30 years, maybe you want to put a larger allocation into this area.”
For her part, Tan prefers to invest in larger companies with a competitive edge over faster-growing, smaller names, which may have less experienced management. “Fundamentally, weʼre not looking for small-cap, potential high fliers,” she says. “We’re looking for businesses that are sustainable, have a competitive advantage and are run by experienced teams that can manage their way through a cycle.”
For advisors, these changes in emerging markets raise an important question: Should they include an allocation to emerging markets in client portfolios? Certainly, Tan believes they should, as emerging markets become more stable long-term investments.
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