Capital Ideas^™

As emerging markets continue their rise towards becoming one of the key drivers of global growth, improved capital and information flow have brought to the fore alternative ways of investing in the asset class. In this paper, we look into the possibility of broadening the emerging market opportunity set beyond the traditional boundaries of geographical domicile, and focusing instead on successful companies that are taking advantage of key secular trends in developing countries.

 

The paradigm shift in emerging markets

One of the biggest developments when it comes to investing in emerging markets over the past few years has been the inclusion of China A-shares into global indices. Index providers such as MSCI have been adding China exposure to benchmarks, amid a continued push by the Chinese authorities to open the country’s financial markets to foreign investors.

Given the size of China’s financial markets, this inclusion has inevitably led to concerns that the emerging market opportunity set is becoming too skewed towards a single country. Investors using passive strategies to gain exposure to emerging markets could inherit concentration risks as they find their portfolios being determined by index weightings rather than the search for good investment ideas. Consequently, it may be worth considering a different approach to capturing investment opportunities within emerging markets. 

Another key development has been an increased reliance on global supply chains. Nowadays, companies tend to have some combination of customers, suppliers and production lines in multiple countries, some of which are likely to be in emerging markets. Despite this, investors often remain tied to asset allocation approaches that define a portfolio’s exposure by where its companies are headquartered, rather than where and how they do business. While traditional domicile-based approaches have been tried and tested over the years, these methods may potentially misrepresent the fundamentals that drive companies, as well as the risks and opportunities within portfolios.

Two industries that are underrepresented by purely domestic emerging market companies are luxury goods and health care, both of which are seeing rapid demand growth from emerging markets. For example, the revenues of French luxury goods group LVMH are heavily influenced by emerging markets, particularly China, where there is no equivalent in the local market. Meanwhile, emerging markets make up the largest geographical segment for AstraZeneca, having generated 35% of the UK pharmaceutical company’s total product sales in financial year 2019.  Not only that, but the segment is rapidly growing, with China leading the way with a 29% year-on-year increase in product sales in 2019.¹ 

 

1. Source: AstraZeneca

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.