Young fundpicker: Navigating risk and opportunities in emerging markets

Not only was globalisation at its peak in human history, but over the last few decades the world has experienced relatively stable geopolitics that has helped sustain and strengthen this growth in interconnectedness.

This has helped contribute to strong global economic growth and less volatility in markets.

Emerging market economies have been a particular beneficiary of this global trade, helping to elevate their growth and help improve living standards.

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If you had invested in the MSCI Emerging Markets index 20 years ago you would have almost made double (579%) what you would have made in the FTSE100 (302.3%) which is reflective of its importance as an investment opportunity.

However, this trend of globalisation has notably lost its momentum.

World leaders -particularly in these emerging economies – now seem more inclined to sacrifice economic prosperity to fulfil their ideological goals with populism gathering force on both ends of the political spectrum.

Geopolitical risk is not new

Geopolitical risk is not new – it has always been a facet of any investment decision.

But during the 12-18 months that I have been researching funds, this risk has intensified.

I would argue that the global financial crisis did not just cause economic upheaval, it ushered in this new age of politics where nationalism and social conservatism have become more salient parts of many countries’ identities.

India and Brazil’s current/past nationalistic regimes are certainly examples of this recent shift. But this is not just limited to emerging markets, Trump’s lightning rise to the most powerful seat in the world and the UK’s departure from the EU also represent these populist shifts.

China has also swiftly ascended as an alternative hegemonic power, with Russia also seeking to displace the US’s grip as a global superpower.

Chinese-Taiwan tensions are growing, with Xi Jinping vowing to reunify these two countries. US-Chinese relations are also at a historic low with the US imposing sweeping trade tariffs to stifle China’s growing power. 

Russia’s recent invasion of Ukraine, however, is the most momentous example of this deterioration in global order and connectedness.

Larry Fink, CEO of Blackrock, went as far as to state that the conflict has “put an end to the globalisation we have experienced over the last three decades”.

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Steven Smith, investment director for the Capital Group New Perspectives fund, does not entirely agree.

“Companies will likely remain global in their production facilities, in their client bases, will probably continue to outsource parts of their production and supply chain,” he said.

“But I think increasingly they will build more locally based operations to strengthen and improve the resilience of supply chains and to get closer to their end markets.

So, I think rather than de-globalisation, I would probably call it multi-localisation or re-globalisation.”

How fund managers are reacting

From an investment standpoint this has all led to more volatile markets, the fear of government intervention, sanctions, and the collapse in the value of your investments – as we saw with Russian equities and Russian equity funds.

When we talk to fund managers, views differ as you would expect.

Some – like Jason Pidcock, manager of Jupiter Asian Income fund – have taken the decision to avoid certain areas completely if they deem the risks to be too large.

“There remains significant state intervention in China, including in the Chinese economy, and I am not comfortable investing somewhere where the state can have such a huge influence. It is my firm view that over time China is likely to underperform as a result of this heavy intervention,” Jason said.

“Furthermore, I expect to see greater friction in the future between the West and China.

There is already a list of Chinese stocks that the US, and therefore other international investors, are not allowed to invest in. I believe that list is likely to grow and if it does I would not want to be forced to divest at the same time as everyone else.”

And it is fair to say that a significant number of investors agree with him given the outflows from Chinese equity funds in recent months.

Other managers are more willing to take on these risks that create very attractively priced assets.

I feel slightly conflicted as although I recognise how undervalued these assets are, I do feel like this growing change in global order will create more conflict.

Yes, investors’ demands of a higher risk premium will be satisfied when investing in some of these regions, which could lead to substantially higher returns, and yes in any country the threat of conflict is a constant.

But you can still achieve superior returns by avoiding this unnecessary risk in countries like China where the threat of conflict is too sizeable.

There are still many undervalued, brilliant businesses across emerging markets that will undoubtedly deepen your pockets in the future.

Joss Murphy is a research analyst at Chelsea Financial Services