Finding Growth in Emerging Markets

When considering an allocation to emerging markets, investors are almost universally seeking growth.

Emerging economies have, indeed, significantly outperformed developed economies, with a GDP growth differential of over 4% per year during the decade from 2006 to 2015, based upon IMF data. For the past few years, however, emerging markets have been subject to deep skepticism over the sustainability of their growth potential, leading many to curtail or even abandon allocations to markets that represent well over half of annual global GDP growth.

This incongruity leads us to two critical questions: First, on a tactical basis, is it time to step back in? And second, more strategically, is there more to emerging markets than beta?

Let’s address the tactical question first. To be sure, emerging markets continue to adjust to a less buoyant external backdrop of gradually tighter external liquidity, slower Chinese growth and softer commodity prices, resulting in a narrower growth differential than we have experienced in the past decade. However, numerous indicators suggest that we are at an inflection point in this cycle, with emerging market (EM) policy adjustment progressing across a large percentage of economies and improving political backdrops in places such as Brazil and Russia.

More structurally, we think the interaction of better demographics and a less burdensome legacy from the 2008 global financial crisis (GFC) means emerging markets have better medium run growth prospects. We expect this to be reflected in approximately a 3% edge over developed market growth over the medium term. Within the context of this 3% growth outperformance, however, although there are several common themes that underlie the growth outlook, there will be a great deal of differentiation across individual emerging market economies, which each face different prospects and challenges.

Which leads us to our second question (“is there more to emerging markets than beta?”) As a simplistic growth play expressed through an equity Exchange Traded Fund (ETF), emerging markets do need to be timed very carefully. The success of a buy and hold equity strategy is extremely sensitive to entry and exit choices. Focusing solely on growth beta, however, is a missed opportunity.

Due to the diversity of economic and political regimes across countries and regions, emerging markets typically offer a plethora of idiosyncratic investment opportunities. While during and following the GFC, global dynamics such as widespread risk reduction and G3 quantitative easing greatly overshadowed local factors, as we move past the GFC era, the market environment is shifting, with correlations reverting to historical levels and individual investment stories reasserting themselves. This presents an exciting environment for an alternative investment approach to emerging markets, whether that be exploiting relative value differentials between monetary policy decisions of individual countries or helping emerging market corporations expand beyond their domestic markets via private equity stakes.

I will speak more about the current state of investing in emerging markets at the 2016 FOX Autumn Global Investment Forum, September 15 in New York City. To learn more about my session and to register, please click here>>