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Missed Opportunities in Emerging Markets

Stockholm (Ekonamik) – “Ten years ago, the investment proposition still was to invest in the emerging markets (EMs) in order to benefit from the superior economic growth prospects relative to the developed markets (DMs),” explains Eelis Hein, sharing the insights he gleaned during the years he was the CIO of FIM Asset Management, in Finland. “Since 2013 EM equity unperformance vis-a-vis DMs, in general, has shown that high growth is not necessarily the recipe to high returns,” he says pointing to the relevant MSCI indices for the two markets.

The story of EMs is intrinsically tied to the rise of China, explains Hein, highlighting the pitfalls of this connection. “Many EM countries’ growth was fuelled by global trade expansion and commodity exports to China, which needed all the material to build up its infrastructure and real estate. Regarding the latter, the commodity supercycle is clearly over.  The former, on the other hand, is depressed by increasing trade tensions and slowing global economic growth.”

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Sorting the Green Wheat from the Market Chaff

However, it is not all doom and gloom. “The best times are, however, not behind us in all respects. EM countries are still ‘emerging’, which means growth and many investment opportunities,” Hein explains. “In the diverse EM universe, one just needs to be selective when choosing in which countries, assets, sectors and themes to get involved. Within the EM space, there are, sectors and certainly companies e.g. in the IT and consumer sectors, where the performance hasn’t shied versus the DM space.”

According to the investment specialist, this is where active asset managers are most relevant. “All emerging markets are, not created equal. There are wide differences in terms of economic structure, growth rate, phase of cycle, business friendliness, political and company governance just to name some.  Actively managed strategies with rigorous security selection may be preferable for long term investors when aiming to more specifically capture the most favourable prevailing themes and trends.”

“Whichever approach is taken, including an ESG factor overlay does add value in all EM investments,” he explains. “Finally, one must not forget, that opportunities of EM growth can also be captured through those developed market companies, which have exposure to e.g. EM consumer demand.”

The Allure and Risks of Passive Investments

The alternatives available to investors simply capture different aspects of the returns available in EMs, according to Hein. “To me, the choice of the investment approach in EM depends on the time horizon and what one wants to capture. Passive index strategies are a good way to capture the overall EM market beta and market moves caused by general macro and policy changes, sentiment, and global money flows. There are a number of reasons why investing through passive products is tempting to investors – costs and ease being the main ones,” the Finnish portfolio manager explains. “They are especially well suited for tactical allocations. More often passive strategies are market cap based representations of different countries and companies grouped within the same index and do not separate ‘good from bad’.

However, according to Hein, it is important to understand the implication of the market-capitalization-weighted indexes underlying passive product. He argues that this underlying foundation makes passive products, “in a strict sense not really ‘passive’, but instead slowly evolving momentum strategies. Money flows to the best-performing stocks and away from the laggards. In a good market, this works to the investors’ advantage. But if the tide turns, these dynamics create a self-reinforcing negative feedback loop, which is a risk especially in situations where true liquidity is tested.”

EM Challenges and Opportunities from the USA-China Trade War

Taking a broader view to consider the main geopolitical concerns plaguing emerging markets at the moment, Hein is keen to highlight the fact that the tensions between China and the USA are not a novel development caused by President Trump’s idiosyncracies. “The US-China trade conflict is not only about trade, deficits and tariffs, but about global technological dominance too. There might be different end motivations and different opinions on means, but the pressure against China is generally backed from both the Republicans and Democrats. Therefore, the struggle will not go away any time soon and will, with time, only vary in its degree of intensity.”

The broad support for this confrontational stance promises to create challenges but also opportunities. “This will mean uncertainty and weigh down on sentiments especially for those countries’ markets dependent on global trade. On the other hand, if one is willing to look beyond the trade war, volatility might create entry opportunities to EM companies with strong brands and barriers of entry. These can be found, for example, in industries that benefit from the consumers of the rapidly growing middle class,” concludes.

Picture courtesy of Eelis Hein.

Filipe Wallin Albuquerque
Filipe Wallin Albuquerque
Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.

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