Emerging markets are more developed than you think
Written in partnership with globeadvisor.ca (Globe Content Studio)
Date: May 22
Emerging markets have long been thought of as a risky asset class that can deliver strong growth in good times, but big losses when there is risk aversion.
While that has been historically true, and investors still take a risk-on and risk-off approach to the many emerging market countries, some of these nations have grown to the point where their domestic companies are as mature as any business in Canada or the United States.
Christine Tan, chief investment officer and senior portfolio manager with Excel Funds, a company recently acquired by Sun Life Global Investments, says it is about time advisors started thinking of many of these countries as relatively safe places to invest, with strong and stable businesses.
“Many of the companies in these countries are as stable as any developed-country business, but they are still growing at a faster clip,” she says.
It’s no longer hard to find cash-flow-generating, large-cap businesses in sectors such as banking, telecom, consumer staples and technology, she says. Chinese tech giant Tencent Holdings Ltd. is a good example, Ms. Tan says. The 20-year-old company has a market capitalization of US$460-billion and its management is made up of seasoned executives, several of whom went to school in the U.S. and have Silicon Valley experience.
“These companies have strong corporate governance. Some are listed in the U.S. and follow U.S. filing and disclosure requirements,” Ms. Tan says.
Solid, but still fast growing
As big as these companies are becoming, they are still growing faster than similar businesses in developed countries, which potentially gives them an edge over their North American and European peers, Ms. Tan says.
“What’s interesting is that, despite their size, they’re still growing very quickly because their home market demographics are so young and the penetration of goods or services is still very low,” she says.
India’s Yes Bank, for instance, has seen revenues grow by 30 per cent year-over-year to the end of 2017, which is much faster than its Canadian peers, even though it’s far bigger than our domestic banks. The Mumbai-based financial institution has an US$11-billion market cap, compared with US$108-billion for Toronto-Dominion Bank.
The Indian bank’s rapid growth can be attributed to an improved regulatory environment, technological innovation and structural changes in the economy, says Rana Kapoor, managing director and chief executive officer of Yes Bank. In just 14 years, it’s become the fourth-largest private sector bank and one of the top five most profitable banks in the country.
It’s hardly surprising that some of India’s private banks and financial companies are growing by as much as 30 per cent annually and generating more than a 20 per cent return on equity, Mr. Kapoor says. As more of its citizens move into the middle class – 380 million people in India are expected to move into the middle class by 2030, according to the Brookings Institute – a broad range of sectors, such as financial services, telecom, automotive and pharmaceuticals have seen explosive growth, he says. The same goes for China, which is expected to welcome an additional 350 million people into its middle class over the next 12 years.
Smaller, yet fast growing countries like the Philippines and Indonesia are also developing rapidly, Ms. Tan says. Indonesia’s population, for instance, is nearly as big as the U.S., but it has a much younger demographic with lower, but growing income levels.
“Imagine where they will be over the next decade,” she says.
Less reliant on the U.S. economy and the U.S. consumer
There is another reason why these markets are less risky than they once were: they are becoming less reliant on the U.S. for their success. A decade ago, these economies were far smaller and heavily dependent on global trade, which meant that any change in global consumer behaviour or the global economy would have an impact on these countries. Now, with a growing middle class and rising domestic consumer spending, they are better able to withstand shifts in the global economy.
Favourable economic tailwinds, such as an emerging middle class, more progressive policies and increased government spending on infrastructure have also improved the resiliency of these emerging market countries. As the domestic consumer becomes wealthier, they will start demanding Western-style goods and services that they do not have as much access to yet, says Ms. Tan.
On the flip side, as emerging market companies get larger and emerging market economies mature, expectations of blockbuster gains must be tempered.
“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,” Ms. Tan says.
However, because emerging markets are still growing at a significantly faster pace, lower levels of volatility can translate into better risk-adjusted returns over time.
“That’s why investors should now 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 to this area.”
Having more mature companies in these markets is a boon for Ms. Tan, who strives to find stable performers in these regions. She prefers large companies that have a competitive edge to faster-growing, smaller names. Why? Because it is important to find management teams that are experienced, and there are fewer among the smaller companies.
“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.”
All this means that financial advisors may want to take a fresh look at the role emerging markets play in their clients’ investments. These are no longer short-term risky bets, Ms. Tan says. Instead, they’re becoming increasingly stable areas of the world that can be viewed as a core part of a long-term portfolio.