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Ignore China at your peril

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Global investment manager Capital Group has a long history dealing in emerging markets, having covered the sector since the early 1990s. Since then, emerging markets have come a long way but suffered a lot during Covid-19. In this article, investment director Valeria Vine and portfolio manager Victor D. John highlight trends shaping the sector’s future.

  • There has been a remarkable transformation with EM markets over the last few decades. John highlights a trip he took to the area many years ago, when he was a research analyst and reports were done by print. So much has changed, he points out; at the time, Korea and Taiwan weren’t really open, and the Chinese market did not exist, yet these three countries count towards two-thirds of the EM index. 

    From being a small backwater sector, EM has transformed, to the point where it accounts for 40 per cent of the world’s GDP on nominal basis with the majority of the world’s population. In the 90s, most of these markets were made up mainly of cyclical industries and mining stocks.

    Today they make up less than 10 per cent of the EM Index with a variety of tech components (TSMC chips), to electronics, digital payments, e-commerce, biopharma, gaming and social media: emerging market companies are innovating and becoming increasingly competitive on a global scale.

    Why then, over the last ten years, have developed markets outperformed emerging markets?

    Looking back at history, EM has performed relatively poorly against developed markets. However, this is all about to change, due to surging demand for commodities on the back of massive global stimulus, infrastructure spending and the rapid post-Covid recovery. John says, “Better growth prospects, younger population, rising incomes – all of these factors support the case for EM.”

    Emerging market middle classes are driving growth in air travel

    “Before Covid, 150 million flew for the first time in Asia. However, over the next two decades, Asia is expected to account for 50 per cent of incremental air travel boosted by a rising middle class. As incomes rise, people travel further, have longer holidays and spend more. And while 2020/21 have been challenging, there is a lot of pent-up demand for travel,” says Vine.

    In China, the domestic portion of travel has recovered. The number of flights and hotel occupancy is back to where it was before Covid. International travel will take some time to recover, but domestic and short haul travel is already on the way up.  

    What impact did COVID have on consumer behaviour?

    Emerging markets are tipped to underpin long-term growth in luxury goods. Vine says, “Every aspect changed overnight. Luxury goods etc. A lot of growth is driven by China that is done during travel. Because there hasn’t been travel, most of the money that would have been spent has been repatriated back home.

    “There has been a defined change in the way consumers spend and where they spend, but the amount spent, and tastes haven’t changed. China remains the dominant force with consumers leading the world in spending on personal luxury goods. A good example of a company that has successfully ridden the Chinese luxury goods boom is Louis Vuitton (LVMH), which has diversified into wine and travel to benefit from growth of luxury in China.  

    Any other sectors benefit from longer term?

    John says insurance is the winner. “Go back to the experience after the SARS outbreak in 2003. Demand for insurance hit historic highs. Covid will be similar, and the impact over the long term will be similar in both life and health insurance policies.”

    Capital Group’s current portfolio is made up of a number of companies in healthcare, biotech and pharma; companies that have innovative products, not just the generic ones, but bringing new products to market. These stock positions have strong management and a research pipeline in drug discovery and development.

    Emerging markets are driving the transformation to digital payments

    During Covid, cash was largely forgotten. The pandemic expedited the long-term structural trend from cash to electronic payments. This can be seen in China, where electronic payments have been widely adopted following the rise of e-commerce platforms during lockdowns. The uptake in digital payment systems in emerging markets such as Indonesia and Thailand has been extremely quick. Consumers have been actively ditching banking products to be replaced with disruptive digital banking services.

    And finally, there’s India.

    Both John and Vine are positive on the most populous and fastest-growing country in world. John says, “India is an exciting place, but is at a much earlier stage of development than China, both income and infrastructure are growing rapidly, and the average population is a lot younger than China. The country also has an entrepreneurial flair and has a lot going for it, especially with recent tax reforms. Over the next decade, the average income is expected to double.”

    Vine says infrastructure is still India’s big problem, and wage costs are not cheaper than China. With improvements in infrastructure and lower taxes, the hope is that India can one day take manufacturing away from China. India’s economic growth forecast is tipped to hit 7.5 per cent for 2021, projecting the country to become the fastest-growing major economy in 2022 with a growth rate of 10.1 per cent.

    In summary, there are multiple trends that Capital Group has outlined that make a genuine case for investing in emerging markets. The fund manager believes “that an on-the-ground presence in these regions and in-depth fundamental research are key to identifying important trends, and finding companies with robust networks and supply chains, while being sensitive to unique intricacies and constraints in these regions. This should ultimately help generate strong long-term investment results.”




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