The centre of global economic activity has seen a clear shift away from Developed Markets towards Emerging Markets since the turn of the century. However, the traditional drivers of growth that have propelled Emerging Markets to this prominence are becoming unsustainable. The next stage of growth will be driven by the rapidly growing middle class and should ultimately prove to be more sustainable and significant.
Emerging markets are becoming a powerful force within the global arena. Their contribution to global growth is now quite significant. China has undoubtedly been the dominant player in this development, but the primary driver to her recent growth – that of capital-intensive fixed investment – is becoming unsustainable. China’s economy has become unbalanced, debt levels are high, the allocation of resources has been sub-optimal and pollution is a challenge. The next stage of China’s development will see growth increasingly led by other parts of the economy.
While this transition won’t be without its challenges, there are certain supportive factors already in place. China’s strong GDP growth has fueled significant expansion in GDP per capita, which has roughly doubled every five years since 2000. More importantly, wage growth has also been strong and income per capita is now reaching a level at which domestic consumption typically starts to grow quickly.
Discretionary spending is expected to account for close to 50 per cent of a household’s total expenditure in urban China by 2025, up from a third in 2000. More broadly in Asia, the middle class is expected to rise from 525 million in 2009 to over 1.7 billion by 2020. This megatrend is about the rise of the middle class and, with it, the rise of aspirational demand.
This next stage of growth in emerging markets presents significant investable opportunities across several industries, including fashion, food and beverages, technology, financial services and tourism. However, these industries are increasingly championed by local companies – participating in this next stage of growth will require a more direct investment approach.
The current volatility in emerging markets may prompt some caution from investors, but valuations have also become more attractive. Rather than dismiss emerging markets, investors could look for active strategies that provide exposure to this theme with lower levels of volatility than the broader market.
One approach that’s gaining interest is to identify companies with sustainable growth that also pay attractive dividends. Dividends are reflective of sound cash-flow generation, good corporate governance and are aligned with minority shareholder interests – key ingredients for emerging market investing. Focusing on growth and dividends can also result in better risk-adjusted returns over the long-term because these factors typically perform better in times of volatility.
Investors traditionally look to emerging markets for growth potential alone, thinking that high yield means lower growth prospects. However, this isn’t necessarily the case for emerging markets. In fact, nearly 92 per cent of companies in the emerging market universe pay a dividend. Cash dividends have contributed substantially to the total return of emerging markets over time.
For investors that are interested in participating in emerging markets, but who are wary of the volatility, perhaps it’s time to consider an active strategy that combines both growth and dividends.
