Deep Dive: Emerging markets are ‘rich hunting ground’ for investors

2021 proved to be a very difficult year marked by several factors: less accommodative policies in the US, the substantial underperformance of Chinese markets against a backdrop of growing concerns over regulatory changes, the increasing risk of default of the second largest Chinese property developer, and the delisting of Chinese ADRs from the US markets. So, following a difficult 2021, what is next for emerging markets? 

Everlasting opportunities in EM equities and bonds

In an environment characterised by rising rates and uncertainties around China, emerging markets will, despite their complexity, be a rich hunting ground for investors in search of attractive growth and alpha generation opportunities, especially for those who know where to find them and how to avoid risks.

The current panic surrounding Chinese stocks, and investors’ bearish view of regions like Latin America and Asia, are offering investors attractive entry points. We should also note the excellent balances of payments in emerging countries which make them less vulnerable to monetary policy decisions in the developed world – a big change since the 2013 crisis, which was triggered by Bernanke’s taper tantrum. 

On the equity side, Asia is the region offering the best opportunities as GDP growth is higher, and it is where we find the largest pool of innovative tech and internet companies that will be at the forefront of the digital revolution, accelerated by the pandemic.

The indiscriminate decline in China has created attractive opportunities for active managers, with some companies offering appealing valuations close to the low levels of the October 2008 crisis. The country has healthier fundamentals, and its slowdown should be avoided thanks to a supportive policy mix. Moreover, the Chinese government is increasing its efforts to rely less on exports and more on consumption, which should benefit local companies and improve the quality of Chinese growth. Domestic companies aligned with long-term government plans offer decent opportunities, in sectors such as tech, consumption, healthcare, and clean energies. 

Concerning EM debt, its context also seems favourable. The real rates in the developed world are making multi-decade lows, contrasting starkly with the environment in the EM world where the real rate differential is at an all-time high. This should benefit EM currencies going forward, that offer attractive (or positive) carry. Moreover, EM tends to benefit from an inflationary environment with rising commodity prices, as they include commodity-rich and manufacturing-supplying countries, which act as a bulwark against inflation. 

We believe the most compelling way to seize their opportunities is through a diversified multi-asset approach that invests in equities, bonds and currencies, across emerging and frontier markets which takes advantage of decorrelation among the different asset classes, regions and sectors. 

Integrating sustainability features in an EM multi-asset solution 

We see a sustainable approach even more indispensable when investing in EM, to guarantee that most of their upside potential is captured, while mitigating the short and long-term risks. This results in a portfolio that has been fully analysed on financial and extra-financial criteria:

• Countries are selected for their fundamentals and are scored using a proprietary sustainability assessment. The investment team allocates an ESG rating on each sovereign bond issuers.
• Sectors are picked based on under-penetration, and positive screening is performed in search of sectors that are improving governance, societal and environmental conditions.
• At a company level, a detailed ESG analysis is done and an ESG rating is allocated to all companies in the portfolio. 

Whether you are an equity investor preferring a more diversified approach to emerging markets, or a fixed income investor

wishing to spice up your emerging market asset allocation with a hint of equity holdings, a sustainable multi-asset solution caters to your needs and will allow you to single out the best opportunities while mitigating the financial and extra-financial risks.

Xavier Hovasse is head of emerging market equities and fund manager at Carmignac