Why investors should give emerging markets a second chance

Investors risk missing out as the sector remains under-owned, under-estimated and undervalued, experts say

The Dubai Financial Market. Gulf countries have become an important player in the emerging market universe. Reuters

Emerging markets were supposed to be the investment of the millennium, but it has not turned out that way.

The sector exploded in a series of acronyms, most famously the Brics (originally Brazil, Russia, India, China and South Africa), but also the Mints (Mexico, Indonesia, Nigeria, Turkey), the Civets (Colombia, Indonesia, Vietnam, Egypt and Turkey) and several others.

Nobody uses these acronyms any more, except as a warning from history.

Lumping together a bunch of wildly different countries was always a bad idea, and a little patronising, too.

Emerging market hype faded as the financial crisis exposed their debt-driven growth models, while US technology stocks established themselves as the true masters of the millennium.

Yet, investing is cyclical. The heavily hyped Magnificent Seven (Apple, Amazon, Alphabet, Facebook-owner Meta, Microsoft, Nvidia and Tesla) may struggle to ride again this year, but there are stirrings in emerging markets. Is it time to give them a second chance?

China became a shorthand for the entire emerging market sector, as years of double-digit gross domestic product growth transformed it into the world’s second-biggest economy and a serious rival to the US.

However, China’s recent growing pains risk overshadowing smaller emerging market economies that have their own stories to tell, more so since Brics expanded earlier this year to add the UAE, Saudi Arabia, Egypt, Ethiopia and Iran as member countries.

Over the past three years, the MSCI Emerging Market Index has slumped 18.9 per cent, but when struggling Chinese stocks are excluded, the return was positive at 6.9 per cent.

Andrew Ness, portfolio manager at Templeton Emerging Markets, says 2024 has the potential to be a better year for emerging markets, which remain under-owned, underestimated and undervalued.

Investors risk missing out. “They are underweight emerging markets, as relative allocations have declined significantly versus 10 years ago,” he says.

Emerging markets carry less debt than the West and greater macro resilience, Mr Ness adds. They are notably cheaper, too, with the MSCI Emerging Markets Index trading at a discount of about 45 per cent to MSCI World.

While investors impatiently wait for the US Federal Reserve, Bank of England and European Central Bank to cut interest rates, emerging markets have already begun easing as inflation retreats.

More will follow suit and that is not the only factor in their favour, says Adnan El-Araby, co-manager of Barings Emerging EMEA Opportunities.

“The US dollar has weakened in recent months and the gap between emerging market and developed market GDP growth is improving, acting as tailwinds for emerging markets,” he adds.

The GCC region continues to benefit from low inflation, steady capital investment and high employment, although volatile oil prices offer some uncertainty, Mr El-Araby says.

In emerging Europe, Poland has the “standout economic outlook”, while a reforming Turkey “provides significant promise”, he adds.

John Citron, portfolio manager at the JP Morgan Emerging Markets Investment Trust, says the Gulf states have become an important constituent of the emerging market universe.

“They look set to offer a broader array of consumer-related opportunities, as the region seeks to diversify from its reliance on the energy sector,” he adds.

Mr Citron also sees “green shoots” in the embattled South African economy, which has suffered prolonged weakness from power cuts.

Chris Tennant, co-portfolio manager at Fidelity Emerging Markets, is excited about Latin America.

Mexico is benefitting from the trend towards “nearshoring”, as US companies bring Asia-based factories closer to home to shorten supply chains, he says.

Brazil is also doing well. “Its trade surplus is at record highs, and with inflation under control and interest rates coming down, we expect a positive tailwind for consumer and corporates over the next year,” Mr Tennant says.

Mexico's BMV stock market jumped 40.92 per cent in 2023, compared with growth of only 9.83 per cent across emerging markets as a whole, according to the MSCI. Brazil rose by 32.69 per cent.

As ever, investors should view past performance figures with caution, especially when they are this impressive.

Emerging market performance remains volatile, with large increases one year often followed by equally large falls the next.

India is now the world’s most populous nation and it is a young country, too, with the average age at just 28, says Jason Hollands, managing director at fund platform Bestinvest.

“Under Prime Minister Narendra Modi, who looks set to be re-elected this year, India is basking in its longest period of political stability since gaining independence,” he adds.

Massive investment in infrastructure is modernising the Indian economy, while international companies are turning it into a supply chain centre.

“Apple plans to shift a quarter of its iPhone production to India by 2025,” Mr Hollands says.

The Indian economy is growing at “breakneck speed” as its rapidly expanding middle class drives consumption, he adds.

“It’s on track to become the world’s third-largest consumer market by 2027, according to a recent report by BMI. India is simply too big to ignore,” says Mr Hollands.

The India MSCI index jumped 22 per cent in 2023 and has delivered a positive return every year but one since 2011.

The sole exception was 2015, when the market dropped by only 1.61 per cent. Usual warnings about past performance apply.

Many private investors will be content with a broad-based emerging markets exchange-traded fund, but they should still check country allocations, which can vary significantly.

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The iShares Emerging Markets Equity Index Fund ETF offers wide coverage of all the big markets, including China (27.16 per cent of the fund), India (21.83 per cent), Taiwan (18.01 per cent) and Brazil (6.73 per cent).

Saudi Arabia, Mexico, South Africa, Indonesia, Thailand and the UAE all feature in the mix.

Recent performance has inevitably been poor, given emerging market travails, with the fund falling 5.49 per cent over the past year. It is up just 13.04 per cent over five years.

By contrast, the Amundi MSCI India II UCITS ETF is up 24.45 per cent over one year and 79.18 per cent over five.

Similarly, the Xtrackers MSCI Mexico UCITS ETF is up 12.43 per cent over one year and 71.69 per cent over five.

As ever, investors should approach with caution. Fund managers have been talking up an emerging markets revival for years. This year could prove another false dawn, for all we know today.

Yet, snubbing emerging markets may be a mistake. We are barely a quarter of the way through the century, giving them plenty of time to fulfil their early promise. That applies to China, too.