Pandemic proves emerging markets’ newfound resilience

While investors struggle to find assets offering continued yield, emerging markets are becoming more attractive, believe strategists at fund house Franklin Templeton, which specialises in trading developing market equities.

“From a policy perspective, emerging markets are a much more resilient asset class today,” with their staying power validated through the pandemic, says Andrew Ness, co-manager of Franklin Templeton’s global emerging markets strategy. “Emerging market economies did not collapse like in the bad old days,” which saw balance of payments crises and defaults.

A much stronger buy-in from local investors has been a key factor to reinforce these markets, he says. “There used to be crises due to foreign investors jumping on the gravy train and then leaving en masse. Now we have deeper capital markets and also local emerging market investors.”

This means the firm has decided to overweight banks in the developing countries. “Their balance sheets are acting as a buffer when there is a global crisis,” says Mr Ness, whose portfolio includes ICICI Bank in India and China’s China Merchants Bank. “Their banking systems do not collapse, because they are still there as a lender to the local economy. There has been no implosion in the banking system and they have weathered the pandemic very well.”

These new dynamics reflect significant change in the opportunity set, with a wider choice of sectors and stocks. “Malaysia, Brazil and Chile were the main markets 25 years ago, all commodity driven,” says Mr Ness. “Now we have a much broader set of drivers for growth.”

Many investors, he adds, have failed to realise that emerging markets have leapfrogged their developed peer group when it comes to global opportunities in research and development-led technology stocks. “They are now the global leaders in deploying technology,” he says. Franklin’s tech holdings include Chinese internet retailer Alibaba and South Korea’s interactive media firm Naver Group.

Among the key trends which portfolio management director Chetan Sehgal has identified are electrification, as most industries move away from reliance on fossil fuels. He favours Chinese stock Guangzhou Tinci Materials, for its dominance in supplying electrolytes for electric vehicle manufacturers, including Tesla.

Other, smaller ticket goods are also benefiting from the trend. “We saw an increased use of batteries and power tools during the pandemic” and more reliance on semiconductors, says Mr Sehgal, with 25 per cent of the portfolio now dedicated to this trend. Semiconductor stocks held include Taiwan Semiconductor and fellow Taiwanese stock Mediatek.

The two main challenges to this growth story, says Mr Sehgal, come from Russia and China. The war between Russia and Ukraine has impacted energy supplies, commodity prices and trade flows. “If people are not importing grain and other commodities from Russia and Ukraine, what does this mean for the rest of the world?” he asks. He does, however believe that emerging market investors who were previously invested heavily in Russia were likely underperforming their peer group.

China’s periodic lockdowns have also introduced an unpredictable “stop-start” pattern to the markets, he says. “If this is just a short-term phenomenon, then that’s OK. If China opens up next year, it’s not so much of a problem. But if it continues for a long time, then there is a risk, as all connections with China will be severed.”

Fund managers must also be able to navigate a fast-changing regulatory environment and favour investments matching with the Communist Party’s two current polices of ‘common prosperity’ and ‘dual circulation’. “This ties in with self-sufficiency in key industries, including semiconductors,” says Mr Sehgal.

In order to sustain its leading role in the Chinese economy, the Communist Party must deliver on middle class aspirations to meet growth, he believes. “Before a policy decision is taken, a lot of debate happens. Chinese people generally believe they have a fair say in how the country is run.”