In focus

How investors can capitalise on the new dawn in emerging markets

Global investors have had various concerns relating to emerging markets (EM) over recent years. These include the dismantling of global supply chains, the difficulty of the middle income trap, lower environmental, societal and governance standards and slowing growth in China. And of course, the fact that EM equities have underperformed relative to developed market equities.

As multi-asset investors, we believe there are plenty of reasons to be positive about investing in EM. And as we start to emerge from the Covid crisis, we expect the post-pandemic period will mark a new dawn for the asset class, driven by three key factors:

  1. Quantitative easing (QE), previously unheard of in EM, is becoming surprisingly widespread.
  2. Yields in EM debt and the income differential between EM currencies and the US dollar are at record lows.
  3. With fiscal balances across EM forecast to widen to historic deficits, solvency and debt sustainability are becoming pressing issues.

This new era will bring about a divergence between strong and weak EM countries, with the former increasing their importance in the global economy and the latter becoming ever more indebted and susceptible to default.

In this paper we suggest three changes that investors could make to capitalise on changes in the post-pandemic world.

These include the need to be flexible to capture the full range of opportunities. For example, understanding which sectors are expected to be the drivers of the future will be important. Sector composition has changed significantly over the past 20 years (see table below), and the index has become far more concentrated.

We also highlight the need to diversify within the EM universe, and consider how EM fits together in a portfolio context.