Today’s emerging markets (EM) are vastly different from what they were just a decade ago. What’s more, some EM-based technology companies have emerged as global market share leaders or close rivals to developed-market peers. In our view, an actively managed investment approach is best suited to navigating this landscape of tumultuous change.
While old stereotypes can at times be shattered by rapid change, it can take a long time for the consensus view to recognize their obsolescence. Such is the case with EM economies, which to this day continue to shake off their old reputations as being dominated by commodities-oriented, extractive industries that ship materials at low cost to fuel the economic engines of wealthier developed markets. While such industries can still play an important role, modern EM economies are much more than that—they’ve diversified to encompass a much broader range of industries and higher-margin goods and services.
Some of the past decade’s biggest EM gains have come in growth industries such as e-commerce, electronic payments, cloud computing services, data centers, online education, and online healthcare diagnostics; growth has also continued apace in more established areas of EM strength, such as semiconductors and computer hardware. Broadly, these are industries where we see an abundance of EM equity opportunities among selected companies that we believe can generate profitable and sustainable growth over the long term―the steady value compounders with strong business fundamentals.
The transformation of the MSCI Emerging Markets Index
A signal of this change is evident in the composition of today’s MSCI Emerging Markets Index, which is much changed from just a decade ago. The rise of EM technology and consumer discretionary stocks has been the key catalyst for this transformation.
As recently as 2010, the combined 28.1% weighting of three sectors that are the source of much of today’s EM growth—consumer discretionary, information technology, and communication services—was just shy of the 28.3% combined share of the more traditionally EM-dominant materials and energy sectors.1 By the end of 2020, the index’s composition had been transformed, with the combined weighting of the trio of more growth-oriented sectors swelling to 47.8% and energy/materials shrinking to 12.9%.
EM equities: a shift from commodities-oriented sectors toward faster-growing tech and consumer sectors
MSCI Emerging Markets Index combined sector weightings (%) for energy and materials versus consumer discretionary, information technology, and communication services sectors, 2010 to 2020
Source: MSCI Inc., 2021. The MSCI Emerging Markets (EM) Index tracks the performance of publicly traded large- and mid-cap emerging-market stocks. It is not possible to invest directly in an index. Weightings subject to change.
The emergence of new consumer and tech leaders
What produced this dramatic shift? Among the key EM catalysts have been rapid middle-class growth in many EM countries and an accompanying surge in disposable income, which has created rising demand for consumer goods, particularly higher-end items.
Emerging markets dominate wealth gains
Average annual percentage growth of wealth per adult in local currencies, selected countries, 2000-2019
Source: Credit Suisse Global wealth databook 2019, Credit Suisse Research Institute, October 2019.
Without these trends, we wouldn’t have seen the rapid growth of Chinese companies such as Alibaba, the e-commerce giant, and Meituan, an online platform for consumer products and retail services, including entertainment, dining, delivery, travel, and other services. Following in their footsteps, we’re seeing the emergence of companies such as MercadoLibre and SEA Ltd. providing similar services to consumers across Latin America and Southeast Asia, respectively, as growth in middle-class consumption spreads across EM.
At the same time, many EM-based technology companies have emerged as global market share leaders or close rivals to developed-market peers, as well as being dominant players in their own domestic markets. Among these select companies are Taiwan Semiconductor, China’s Tencent Holdings—a multinational technology conglomerate and vendor of video games and internet-related services—and South Korea’s Samsung Electronics.
Each of these three technology companies ranked among the top five constituents of the MSCI Emerging Markets Index as of March 2021.2 The other top 5 companies are the abovementioned consumer discretionary names Alibaba and Meituan. Consumer discretionary also boasts the index’s sixth and ninth positions, South Africa-based internet services company Naspers and JD.com, a Chinese e-commerce company. Just outside the top 10 was another new economy stock, China’s Baidu, a provider of internet services and artificial intelligence.
Over a decade, the EM share of the worlds’ top consumer brands has grown nearly sixfold
Countries' shares by value (%) of the world's top 25 brands, 2011 to 2021
Source: Global 500 Rankings, Brand Finance, 2021. Percentages may not total 100 due to rounding. Subject to change.
A new EM equity landscape opens new opportunities
This is a completely different environment than when we began our EM investing careers decades ago. Since then, the global growth of the middle class and its magnified buying power have reshaped EM, and the pandemic’s emergence in early 2020 became a further catalyst for change. In the face of a devastating global health crisis, a select group of firms within specific industries has shown remarkable resilience and even managed to accelerate growth.
Amid supply chain disruptions and other operational challenges, many of these standout companies became beneficiaries of work- and shop-from-home trends, and the strong growth that they experienced before the pandemic in some instances accelerated further. This growth has been most notable in several North Asian markets that we continue to believe will shape the next decade of EM opportunity.
A shift in the storyline
Of course, these sorts of long-term trends rarely play out in an uninterrupted fashion, and that’s been the case in late 2020 and early 2021. The relative performance of some of these companies retreated as investors rotated into a broader grouping of more traditional cyclical stocks and sectors. Many of these segments are expected to benefit more significantly over the short term as economies gradually reopen, with vaccination campaigns and the drive toward herd immunity suggesting a march toward normalization.
Many investors may have viewed these stocks and sectors as undervalued, given the growth premium that had driven up the prices of many new economy stocks through much of 2020. While there has been a broad recent trend toward economic normalization, it’s important to remember that this trend, too, is unlikely to be synchronous; across developed markets and EM, the success of many countries’ vaccination programs has been uneven, and the emergence of new COVID-19 variants and case surges has produced renewed lockdowns across several important economies. We believe such pandemic-driven unpredictability is likely to persist for the short term.
The bigger picture for new economy stocks
Taking a longer view, we believe that a substantial share of EM earnings growth will be driven by stocks in industries that are beneficiaries of the work- and shop-from-home shift, such as semiconductors, technology hardware, e-commerce, and media and entertainment. In our view, well-managed new economy EM companies with strong business models will continue to provide fertile long-term investment opportunities. However, our experiences as active investors show us that changes in the makeup of the EM equity universe are to be expected, and given this dynamic nature of EM, a focus on longer-term secular growth drivers is best suited for the asset class.