After years of buoyant market conditions that have driven strong market performance across the board, investors are questioning for how long this “Goldilocks” regime can last and which investment areas will continue to offer opportunities in the near future.
In this respect, we believe that Emerging Market (EM) assets still offer potential return opportunities, especially when compared to Developed Market (DM) assets, as positive cyclical and structural dynamics are at play. Among the most important of these, we point to the following: the transformation of EM economic models which are gradually becoming more balanced towards internal demand; the structural reforms in process in several countries; the improvement in governance at EM companies; supportive earnings growth dynamics; and the development of new markets and sectors.
All these positive factors signal bullish sentiment towards EM and help drive flows into the asset class, especially to EM debt and, more recently, a renewed focus on equities. However, as we enter a more mature phase of the global financial cycle and a more uncertain market environment, with central banks (CB) further tightening monetary conditions, investors are questioning if this bonanza is set to continue. The key question is which risks, opportunities and approaches could benefit the most in this new market phase?
In our view, while tightening of monetary policy in DM, especially the US, poses a number of challenges to EM economies and to its leveraged corporate sector, EM are now better equipped to deal with these risks. These economies are generally less vulnerable than in the past and the global economic backdrop is supporting more resilient economic models.
For these reasons, we believe that the next phase for EM will be less a story of “superior growth” and more one of “sustainable growth”. In this new phase, strong differences among countries will still persist and determine different development paths and, as a consequence, areas of risk and opportunity for investors.
Given this backdrop, we think investors should reassess the role of EM assets in a portfolio. EM should become more relevant in strategic asset allocation.
Investors should also consider moving away from an “asset class” perspective regarding EM and embrace a more selective approach in order to capture country, sector or even company-specific stories and avoid areas of major risk. To do this, investors should develop a solid understanding of the macro backdrop for each country to identify the best investment themes and further exploit how to play them in EM equity and/or bond investing based on a deeper bottom-up analysis. An integrated approach, analysing EM through multiple lenses (country, credit and geopolitical risk; macro and micro reform momentum), will in our view be key to understanding a complex and rapidly evolving world. Moreover, being able to analyze an investment case looking at the full capital structure and bringing together varied expertise (loans, debt, equity, distressed situations) can be a distinctive competitive factor to unlock returns from all the available sources and to enhance opportunities from market dislocation.
Head of Emerging Markets