This article appears in the Mid-November 2020 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
Aside from China, emerging markets’ economic activity is expected to drop this year. The International Monetary Fund (IMF) predicts GDP in China will grow by 1.9% in 2020, while GDP in other emerging markets will drop by 5.7%. In comparison, the global economy is expected to contract by 4.4% this year, the IMF stated, and U.S. GDP is forecast to drop by 4.3%.
High population growth and low personal income make emerging countries vulnerable to even modest economic contractions. Some emerging markets are particularly vulnerable to Covid-19 due to overwhelmed health-care systems, dependence on external sources of finance and plummeting tourism.
Among emerging markets, Asia is the region best positioned for recovery. However, India has suffered rampant coronavirus cases and the IMF forecasts Indian GDP will plunge by 10.3% this year. India’s lockdown last spring was one of the world’s most severe, killing jobs and shrinking the economy by 24% in the second quarter. Latin America also faces a deep recession, with an 8% drop in growth predicted for 2020.
Inequality among countries could worsen, as many developing countries lack the financial resources to deal with the continuing pandemic. Many developing countries also face high borrowing costs. Other downside risks for emerging markets include trade conflicts and geopolitical uncertainty.
While the effects of a Joe Biden presidency in the U.S. remain to be seen, he is expected to take only a slightly easier stance with China on technology and trade issues than outgoing president Donald Trump does, although relations are likely to be more stable under Biden.
Stock markets in emerging countries have held up reasonably well on average this year, with the MSCI emerging markets index (C$) showing a year-to-date return of 1.79% as of Oct. 31. However, as in U.S. markets, the performance of a few e-commerce and IT stocks fuelled returns.
Of the almost 1,400 securities in the MSCI index, just Alibaba Group Holding Ltd. and Taiwan Semiconductor Manufacturing Co. Ltd. accounted for more than 40% of the gain in the first three quarters, according to a report by New York–based Lazard Asset Management LLC. In addition, Chinese stocks were responsible for more than 35% of the index’s recovery from the March bottom, with Korea’s and Taiwan’s markets combined contributing another 30%.
The biggest question looming over emerging markets is when and how effectively they will emerge from Covid-19, says Matthew Strauss, vice-president and portfolio manager with CI Investments Inc. in Toronto. Strauss manages the CI Signature Emerging Markets Corporate Class fund.
“The global health crisis caused by the pandemic has turned into an economic, financial and government policy crisis, which is much more complex for emerging markets to handle than [for] stronger developed countries,” Strauss says. “We’ve already seen uneven responses in different regions. Some countries have the capability for massive monetary and fiscal stimulus, and some don’t. As we come out of the crisis, uneven growth will be evident.”
The CI fund boasted a top-decile return of 10.03% year-to-date as of Oct. 31 and a three-year average annual compound return of 5.6%, according to data from Chicago-based Morningstar Inc.
Strauss says countries that were struggling before the crisis — including Turkey, South Africa, Russia, Brazil and other Latin American countries — are the most vulnerable, as many are capital-deficient and hampered in their ability to stimulate weak economies. Cutting interest rates, as Brazil did, can be problematic for attracting buyers for government bonds and raising capital.
“We still don’t know for certain how the pandemic will play out, or when a vaccine will be available and widely distributed,” Strauss says. “Consumers need to feel comfortable and willing to spend as before, rather than saving because of uncertainty about how long tough times will last.”
Asia-based companies, especially those based in China, account for more than 75% of assets under management (AUM) in the CI portfolio. Latin America is next, but way behind, at about 10% of AUM.
Strauss recently reduced exposure in India due to its health-care crisis. Furthermore, he says huge debt and large deficits are constraining the Indian government’s ability to introduce effective stimulus measures.
Trade tensions between the U.S. and China escalated under the Trump regime, and a speedy return to globalization is unlikely. Asia has been moving toward more regional manufacturing and consumption, Strauss says.
“There has been a focus in China on domestic consumption, and this has been a positive economic influence for the countries that surround [China], stimulating local trade and creating a vibrancy in the region,” Strauss says.
China managed to get a fast handle on the coronavirus, moving early to introduce lockdown, tracking and containment measures. Therefore, the country has been able to reopen earlier than many other countries, including the U.S.
Significant Chinese holdings in the CI fund include Alibaba and Tencent Holdings Ltd., both tech giants that benefit from the massive trend toward e-commerce and social media use.
Other names in the CI fund that benefit from people spending more time at home include NetEase Inc., a China-based mobile-gaming company; Delivery Hero SE, a Berlin-based online food-delivery business that operates in 44 countries; and Meituan-Dianping, a shopping platform in China for consumer products and retail services, including entertainment, dining, delivery and travel.
The CI fund holds other tech companies, such as chip-maker Taiwan Semiconductor, Korea-based Samsung Electronics Ltd. and China-based data-centre developer GDS Holdings Ltd.
Within Latin America, Strauss has sought stocks that can prosper despite the tough economic backdrop. A key holding is Argentina-based MercadoLibre Inc., a fast-growing online retailer considered the Amazon of Latin America and another beneficiary of the e-commerce boom.
Peter Lampert, portfolio manager at Mawer Investment Management Ltd. in Calgary and lead manager of the Mawer Emerging Markets Equity Fund, also favours Asia. He’s invested 70% of the fund’s AUM in China, Korea and Taiwan.
“These three countries had healthier economies prior to the Covid pandemic and they have managed well,” Lampert says. “Covid has highlighted the differences [in these countries] relative to other countries, such as India, Brazil and South Africa.”
As of Oct. 31, the Mawer fund had a top-decile return of 10.1% year-to-date and a three-year average return of 5.4%, according to Morningstar.
Lampert anticipates China’s healthy growth will continue due to its momentum as a rising world power. The Mawer fund’s return has been boosted by its investments in Alibaba, Tencent Holdings Ltd. and NetEase.
“The more traditional businesses like banks, telcos and oil companies that led growth in the past in emerging markets have not kept up,” Lampert says. “Structural shifts that were already underway have been turbocharged by Covid. We’ve seen two years’ worth of digital adoption by consumers happen in a few months.”
Another holding in the Mawer fund that has done well is Momo.com Inc., the e-commerce leader in Taiwan. Momo grew quickly from a relatively low base as online shopping activity took off.
“Asian consumers are addicted to their phones, and the growth of e-commerce has been staggering,” Lampert says. “The online trend has received a boost from the pandemic, but is also accelerating as more powerful phones come out. The electronic games industry is huge — bigger than movies or books — and it appeals to all ages and both genders.”
The Mawer fund currently holds 51 stocks and stays within a range of 40 to 80 holdings.
“We take a long-term view and seek resilient businesses with low levels of debt that can ride out tough times,” Lampert says.
While travel was a positive theme prior to Covid, Lampert has sold Thailand-based Minor International PCL, which operates hotels and restaurants throughout the Asia/Pacific region and has heavy debt. Lampert still is optimistic about the long-term prospects of other travel-related holdings such as Shanghai International Airport Co. Ltd. and TravelSky Technology Ltd. — the latter of which provides software for airline bookings in China — but he trimmed positions in both.
Although finding attractive prospects outside of Asia is more challenging, Bolsa Mexicana de Valores, which dominates the trading of Mexican stocks and bonds, is a strong company held by the Mawer fund.