A Newly Affluent Middle Class Seeks the Finer Things in Life
By Gerald Du Manoir
Equity Portfolio Manager
Investing in developing economies used to mean buying shares of companies that were based in the local markets they served. But as global commerce has expanded — and the world has grown ever more connected — it has become increasingly important to consider where companies sell their products rather than where their physical headquarters are located. Many large U.S. and European companies, for example, get more than half their revenue from outside their home countries.
This revenue-based investing approach is more relevant than ever today amid the rapid expansion of the middle class throughout the developing world. Not long ago, achieving middle class status in emerging economies meant having a refrigerator, a microwave or an air conditioner. Now desires are shifting as improved living standards put modest luxuries within financial reach. People are spending more on everything from restaurants and dry cleaning to cable TV and travel. They’re also increasingly interested in quality-of-life issues, such as better health care and education. Like consumers elsewhere in the world, they’re drawn to products and services offering greater safety, quality and convenience.
In China, for example, spending on liquor, foreign vacations and medical care has increased as disposable income has risen. Consumers now buy twice as much liquor as they did in 2006. Medical expenditures are up about 30% since 2009, while new-car registrations are up more than 40%. Chinese tourists made nearly twice as many trips to Europe last year as in 2010.
Shifts in consumer spending patterns will fluctuate with economic cycles and region-specific factors. But increased consumption in developing economies offers significant growth opportunities for companies that can supply the demands of these consumers regardless of where in the world they are headquartered. The world’s biggest distiller, for example, is based in London. Likewise, there is meaningful opportunity for airplane manufacturers as newly affluent vacationers fly both internationally and within their home countries.
This drastic change underscores a broader transformation under way as emerging nations slowly transition from investment-led economies to consumption-driven ones. For years, growth in China was driven by huge infrastructure projects, such as highways and power plants, many of which were government-financed. Chinese leaders are trying to boost consumer spending, which now makes up a little more than one-third of the country’s gross domestic product, according to the World Bank. Throughout the developing world, infrastructure spending, which once contributed half of GDP, is expected to drop to about 30% as domestic consumption rises.
The effects of rising affluence can be seen across many industries and countries.
Growing prosperity in developing economies now extends beyond the middle class. Rising income levels have allowed an increasing number of people to enter the upper middle class — and in some cases even the upper class. These are projected to be the two fastest-growing income brackets in many parts of the developing world over the next five years. In China, Russia and Brazil alone, about 440 million people are expected to become part of the upper middle class (or upper class) by the end of this decade.
Projections like that underscore the long-term potential of developing economies, which my colleagues and I at Capital Group have emphasized for some time. In the next decade, emerging economies are expected to account for nearly half of total global consumption, or about $30 trillion.
That dynamic will provide compelling long-term investment opportunities for our clients. As affluence grows, there will be a jump in demand for banking and other financial services. Spending on medical care, pharmaceuticals and health-related products will also increase. For example, according to one study, 70% of people in developing economies don’t realize their vision could be improved with glasses.
Incomes are rising as well. In Mexico, for instance, only 3.6 million households — 18% of the nation’s total — had more than $15,000 in annual disposable income in 1995. By 2012, that group had jumped to 18.2 million households, or 61% of the total. Spending on health care, housing, education and air travel surged more than 500% during that time.
It’s critical to understand where in the world companies are selling their products.
The ability to spotlight trends in the developing world underscores the detail-oriented analysis we do here at Capital Group Private Client Services. My fellow equity portfolio managers and I perform extensive on-the-ground research to identify themes that hold long-term investment promise for our clients.
A Capital Group affiliate was one of the first asset managers to venture outside the U.S. when it began investing overseas in the 1960s. As other asset management firms followed suit, it became commonplace in the industry to analyze a potential holding based on where it was located.
As globalization has reordered the economic world, we now focus much less on where companies are based and more on where they sell their products. Most midsize and large corporations today have customers, suppliers and production facilities spread around the globe. Revenue-based analysis helps us identify companies with exposure to the fastest-growing parts of the world.
For instance, even though developing economies themselves have small automobile industries, they account for 31% of global demand for cars and related products. That’s twice as much as Japan, despite the industry’s huge importance to that country. Understanding how companies derive their revenue can also provide an advance warning about potential areas of trouble. For example, given the persistent economic weakness in Europe, identifying companies with sizable exposure to European consumers is important.
As developing economies continue to mature in the coming years, they will offer promising investment opportunities. We believe the growing affluence of the middle class in these economies will have a significant effect on consumer tastes and spending habits, and will open new possibilities for companies around the globe.
Gerald Du Manoir is a Global Equity portfolio manager at Capital Group Private Client Services. He has 24 years of investment experience, all but one of them with Capital Group.