As we enter 2022 we can expect robust fundamentals to serve as a key tailwind for emerging markets (EMs). From a top-down perspective, regulation noise in China, ongoing Covid concerns, geopolitical risk and inflationary pressures have all weighed on sentiment. However, we remain excited by the opportunities we see across the asset class.
In terms of US-China relations, we can expect the Biden administration’s stance to remain unchanged given the bipartisan support in Washington for its policy towards Beijing, with the administration also likely to have the support of allied countries. We are also monitoring the optionality around US-China trade tariffs, as US Treasury Secretary, Janet Yellen, explores relaxing Trump-era tariffs to help ease some inflationary pressure.
Although vaccine optimism has fuelled positive investor sentiment globally, we still envisage distribution challenges in the near term. We are continuing to monitor the scale of new infection waves globally while considering the risk of new variants. Meanwhile, the outlook for inflation remains a key issue for both emerging and developed markets, as central banks may begin to moderate monetary policy accommodation.
It’s fair to say that concerns over the US Federal Reserve tapering still have an impact on sentiment related to emerging economies. In 2013, the “fragile five” were identified as most at risk due in part to their large current account deficits. This still weighs on investors to some degree. However, the notion of the “fragile five” is no more, it seems to be just Turkey which is vulnerable. Even if we exclude China, which has a large current account surplus, in aggregate emerging economies are in a current account surplus. This doesn’t mean the market won’t react to concerns over Fed tapering and ask questions later, but when they do ask questions they will get much better answers than in the past. From an investment perspective we will use the sentimental market reaction as an opportunity to add to specific companies which we like long term.
EMs are breaking away from their dependence on the developed world, with heightened domestic demand increasing resilience to external forces, the development of local debt markets and the stabilisation of the interest rate differential between the US and emerging economies. Therefore, we don’t have the same weakness in different pain points.
We also place a lot of importance on ESG (environmental, social and governance) characteristics, which will no doubt become yet more important throughout 2022. Understanding how well a company manages its material ESG risks is key to assessing the quality of an investment. The focus of our ESG research approach is to understand exposure to, and management of, factors which have an impact on performance through regulation, physical threats to assets, brand and reputation, and operational costs. We follow a best-in-class approach and assess companies against peers.
More broadly, we believe the key long-term trend for EMs is the transition from predominantly export-led growth to reliance on buoyant domestic demand. This is reflected in the change of composition of the universe, which is now dominated by higher quality structural growth companies with a domestic focus. In 2008 more than 60% of the universe was exposed to cyclical growth; today around 60% of the universe is exposed to structural growth. Furthermore, there has been nearly a 90% increase in the number of companies coming to the market in the past decade. We believe the innovation of the universe, in both depth and quality, is ideal for stock pickers and is where we can add value in active management. Investors should now be looking at EMs through a different lens.
