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Darius McDermott: Four reasons to back emerging markets from here

04 June 2024

Chelsea Financial Services and FundCalibre managing director Darius McDermott examines the catalyst for continued outperformance from emerging markets.

By Darius McDermott,

Chelsea Financial Services

The last decade has been challenging for investors who have backed the emerging markets (EM) growth story. In that time the MSCI Emerging Markets index has produced around a third of the returns produced by developed markets (73% vs. 213%)*.

There are plenty of reasons for this – many EM economies have suffered since the 2001-2010 boom, which was fuelled by the likes of China’s rapid growth and the commodities super cycle. This is because many had uncompetitive currencies and failed to reform, particularly among those who exported commodities. The US dollar has also been largely strong since 2014, hampering US-dollar earnings-per-share growth for EM companies. We’ve also seen commodities prices ease, China’s growth engine slow and intensified geopolitical concerns.

The start of this year saw the MSCI Emerging Markets index fall 4.7%, the largest fall since January 1998**. This was because investors believed the strength of the US economy would lead to the Federal Reserve holding rates at their peak for longer. But the expectation of loosening financial conditions (lower rates) across the globe has started to initiate a broader recovery, with riskier assets like EMs up 6.1% in the past three months alone***.

Could a recovery in earnings growth, resilience in the US economy and the potential peak in US interest rates be the catalyst for continued outperformance in EMs from here? Clearly there are still dangers, there are plenty of elections in the region this year (not to mention the US), while many believe there is a lagged effect from high interest rates which will drag on the economy.


Falling rates one of a number of reasons for optimism

Although more rate cuts were anticipated at the start of 2024, the expectation is they are not too far away now and they should benefit many EMs, particularly areas like Latin America. This is where the US dollar comes into play, as rates come down in the US the dollar should stabilise (it will not be as strong) and weaken against other EMs. History shows the positive impact of rate cuts on EMs – with equities in the region rising by an average of 14% in the initial 12 months following the first Federal Reserve rate cut****.

GDP growth in EMs is also accelerating at a time when it is slowing in the developed world. Figures from the International Monetary Fund project growth of 1.7% and 1.8% for developed world economies in 2024 and 2025 respectively (vs. 4.2 per cent for EM’s in both years)^. Part of this is because EMs came out of Covid later, meanwhile EM consumers were not supported by governments in the emerging world, this means the recovery for the consumer has taken longer.

The third point is the ripple effect of China’s underperformance on EMs. Having fallen over 40% since February 2021, the re-rating of its equity market has been indiscriminate – and that has created plenty of valuation opportunities in the region for active managers^^.

Then there is earnings growth and valuations across the board. Consensus earnings growth for EM in 2024 and 2025 stands at 19% and 15% respectively, compared to 11% and 13% in the United States**. Meanwhile valuations look compelling, with EMs trading on a price-to-earnings multiple of 12x, compared to 18.9x for the developed markets and 21.9x for the US**.


Dispersion the order of the day

As we know many of these markets have different drivers supporting their growth today, so dispersion across countries and sub-regions is likely to be rife. Research from S&P Global indicates growth may moderate for many countries that outperformed in 2023 (such as Brazil, Mexico, and India) but remain relatively strong. By contrast those who underperformed last year (Colombia, Peru, Thailand, Hungary, Poland and South Africa) will grow modestly faster this year^^^. 

When you add in the long-term demographic tailwinds and the rise of the middle-class, EMs do look attractive at this point, but you have to accept those bumps in the road. You also have to have a view on China and the impact it has on the wider region, but there are now plenty of different ways to invest across the region without being tied to one specific theme.

Those looking for exposure to the asset class might want to consider the likes of the JPMorgan Emerging Markets Investment Trust, which invest in around 60-100 high quality business, with the average investment held for 10 years. An alternative high conviction name would be the FP Carmignac Emerging Markets fund, a high conviction portfolio of 35-55 large and mid-cap firms.

Those who want a reasonable exposure to China may want to look at the FSSA Global Emerging Markets Focus fund, managed by Rasmus Nemmoe and Naren Gorthy, which currently has a third of its exposure in the country with names like Tencent, Tsingtao Brewery and sitting in its top 10 holdings^^^^.

By contrast, those who are wary of China might look to the likes of the Jupiter Asian Income fund, with manager Jason Pidcock citing political concerns as the main reason for not investing in China. He sold his last remaining mainland China stocks, as well as one Macau-based business, in July 2022, but had been underweight China for some time, due to his low expectations of corporate profitability relative to the rest of the region. Pidcock aims to yield 20% more than the respective benchmark. The portfolio is typically high conviction with between 30-50 stocks held. The focus on large companies with reliable returns, makes it an attractive defensive option.


*Source: FE Analytics, total returns in pounds sterling, from 30 May 2014 to 30 May 2024

**Source: Lazard, Outlook for Global Emerging Markets, April 2024

***Source: FE Analytics, total returns in pounds sterling, from 27 February 2024 to 27 May 2024

****Source: Franklin Templeton, 8 January 2024

^Source: International Monetary Fund, World Economic Outlook, April 2024

^^Source: FE Analytics, total returns in pounds sterling, from 1 February 2021 to 30 May 2024

^^^Source: S&P Global, Economic Outlook Emerging Markets, 26 March 2024

^^^^Source: fund factsheet, 30 April 2024


Darius McDermott is managing director of Chelsea Financial Services and FundCalibre. The views expressed above are his own and should not be taken as investment advice.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.