It is fair to say that most emerging markets (EMs) have now “emerged”, but like most large cohorts, it is worth lifting the lid a bit to make sure you are accessing these markets in the best way.
To begin, a few bits of evidence to bring out the first statement that they have indeed emerged. Emerging and developing economies are now almost 60% of the world’s gross domestic product (GDP), and growing, and they have some of the highest rates of real GDP growth. This share of GDP will only continue to increase and is driven by long-term systemic trends.
EMs are the home of close to 90% of the world’s population – give or take six billion people – and it is a younger population.
Australia is about 2% of global share market capitalisation. Clearly the majority of investment opportunities lie outside our shores, and this includes sectors and stocks not well represented in the Australian Securities Exchange (ASX).
China now accounts for 40% of the MSCI EM index and is less vulnerable than other EMs with the fiscal and monetary wherewithal to rebound from temporary economic setbacks.
China has spent only 5% of GDP on stimulus during the COVID-19 pandemic, less than the 13% of GDP spent by the US leaving it room to spend more if necessary.
We think that a better investment outcome comes from drilling down a bit deeper. It comes as a surprise to some that 80% of the EM index is now Asia ex Japan. This raises a couple of key questions. What is the 20% difference? Is it performance additive or is it problematic? The following tables show us the make up the MSCI EM and the MSCI Asia ex Japan indices.
As well as Asia ex Japan making up 79.1% of the EM index, Greater China (China, Hong Kong and Taiwan) make up over half of the EM index, and two-thirds of Asia ex Japan.
What are the main differences? Four countries out of the 17 that are not Asia ex Japan comprise 15% of the EM index. Brazil, Russia, South Africa and Saudi Arabia. The remaining 13 countries total about 5%.
Essentially, those four countries are strongly linked to commodities and also have some material governance and social issues, bringing significant volatility. Some argue that they are purely opportunistic plays in emerging markets.
In the end, we believe that outcomes matter most to clients. Asia ex Japan with its greater stability, population and opportunities versus EM has also delivered better outcomes, as exhibited in the charts below, where the respective indices show the result clearly.
We would add, too, that EM countries generally are countries where markets still have inefficiencies and greater stock picking opportunities, especially when there are feet on the ground with local contacts and expertise.
So – we completely agree that EMs are a strong opportunity, but the numbers show that EM’s strength is really Asia ex Japan.
Jonathan Wu is executive director at Premium China Funds.
