Look to emerging markets for higher returns - Andrew Ness

note-0For investors in search of resilient returns after a year of instability, there are several reasons to look note-1 to emerging markets.

Tech-related giants in emerging markets are performing well

Firstly, key emerging markets, particularly in East Asia, have been highly effective in managing the Covid-19 pandemic. Their health outcomes, economic resilience, and equity market performance have proved drastically superior to much of the West. China handled the pandemic response well and quickly rebounded. Its manufacturing supply chains, for example, were highly resilient and returned to near full capacity quickly following the outbreak. Taiwan’s navigation of the outbreak is also testament to the quality of its governance and health care systems, with 1,078 confirmed cases and only 11 deaths. Control of the virus in East Asia has enabled broader economic recovery and earnings visibility, giving markets confidence. In this context, the region remains well placed to lead global markets.

Aside from how well some emerging markets contained Covid-19, these countries also have some fundamental qualities that make them an exciting prospect for long-term investors facing a world changed by the pandemic.

Emerging markets are at the forefront of technological innovation. Their very nature has moved away from an old-economy model that relies on materials, energy, and industrials. In its place is a new economy fuelled by technology, communication services, and the consumer. Asia is home to a variety of tech-related giants that stand to benefit from structural trends which have been reinforced by the pandemic. First, there are the internet orientated companies, including Tencent and Alibaba in China, Naver in Korea, and outside of Asia, businesses such as Yandex and B2W. E-commerce and online entertainment and services have boomed. In addition, TSMC of Taiwan and Korea’s Samsung Electronics are the key technology enablers of an increasingly online driven world – with the semiconductor chips they produce providing the computing power in everything from mobile phones to electric cars.

We expect these businesses with high sustainable earnings power to continue to perform well, despite the likelihood that growth rates of internet-based companies may slow slightly after the Covid-19-related acceleration of last year.

In addition, growing middle-class populations with more spending power are providing a significant opportunity from a consumer penetration and premiumisation perspective. Many Chinese consumers are looking to spend their money on better things, experiences, products, and services. This trend will continue to drive demand for trusted brands and value-for-money products, and in turn help stimulate economic growth. China was also the only major global economy to avoid a contraction in 2020, with its GDP expanding 2.3 per cent.

With an economic recovery unfolding across most emerging markets, led predominantly by East Asia, this should lead to more growth prospects. And even the laggards over 2020 such as India and Brazil stand to benefit from a uniquely accommodative environment of negative real rates, ongoing reform efforts, and excess capacity in their economies to support growth.

Lastly, emerging markets proved more resilient than the developed world in 2020 from a stock performance perspective. The MSCI Emerging Markets Index was largely flat, returning -0.11 per cent from 2019 to 2020, compared with an 11.77 per cent fall in the MSCI World Index. This is reflective of the fact that many companies, particularly those in East Asia, successfully executed during the pandemic and should emerge from the crisis in a stronger competitive position. Nonetheless EM equities continue to trade at a discount to developed markets, and what has in the past arguably been a discount due to higher risks in EM looks questionable after the 2020 Covid-19 debacle in the West.

Looking forward, these factors should continue to drive improved earnings visibility for emerging markets into 2021. For so many different markets across this landscape to concurrently offer compelling investment potential, individually and in aggregate, presents an unusual investment window. As is evident to many of us locked up at home, the challenges from Covid-19 remain prevalent. While many countries have started inoculation, the production and distribution of vaccines at sufficient scale will remain a challenge. As such, we expect many countries to continue to experience sporadic viral outbreaks, which will add volatility to the underlying trend of economic and market recovery.

Investment opportunities outside of the UK are broad and diverse. For the long-term investor, considering emerging markets as part of a well-diversified portfolio could indeed help those looking to claw back their losses after a tumultuous year.

Andrew Ness, Portfolio Manager, Templeton Emerging Markets Investment Trust (TEMIT)