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Emerging Markets: Wide Open INVESTMENT PERSPECTIVES Emerging markets: Wide open Constituent countries of the Global investors can manage their Homegrown companies that MSCI Emerging Markets Index capital appreciation objectives and compete at world-class levels of have experienced a growth improve overall portfolio resiliency efficiency are found with increasing miracle this century, propelling the by capturing the diverse secular prevalence in many countries and asset class to core status within return drivers that emerging sectors across emerging markets, a representative global equity market equities can contribute to offering skilled investors many portfolio today. well-constructed portfolios. attractive selection opportunities. Introduction Berkeley Street Emerging Markets Equity Team Each January, the CES (formerly, the Consumer Electronics Show) showcases a wide range of the latest tech gadgetry from consumer electronics giants as well as many lesser-known upstarts from around the world. In keeping with the times, CES was a fully virtual event in 2021. In the last live event held in Las Vegas in 2020, self-driving cars and related technologies were the topics of no fewer than 18 sessions spread over the course of 4 days. Google’s Waymo and GM’s Cruise were joined by a variety of industry Derrick Irwin, CFA stakeholders, niche players, and lesser-known competitors. One of these was Yandex, Portfolio Manager, a Russian company that is actively developing autonomous driving software among WFAM its portfolio of technology-related business, which, according to Statista, includes a 60% share of the Russian internet search market. In 2020, significant performance improvements in Yandex’s autonomous driving software were demonstrated with 20-minute driverless test rides that shuttled over 100 passengers through the pedestrian-lined streets of Las Vegas, giving the company’s better-funded competitors a run for their money. The company has continued its rapid advancement in the space, Bob Hrabchak, CFA 1 Senior Portfolio Specialist, reporting over 7 million miles of autonomous miles to date. Yandex has carved out a WFAM credible presence among the experimental technologies that are making autonomous transportation a commercial reality, globally. 1. Yandex Self-Driving Group Clocks 7 Million Autonomous Miles, Forbes, 5/3/2021. The information shown is not intended to be, nor should it be construed to be, a recommendation to buy or sell an individual security. FOR INVESTMENT PROFESSIONAL USE ONLY – NOT FOR USE WITH THE RETAIL PUBLIC June 2021 At the turn of this century, most professional investors Investors may have again allowed recent emerging market were well aware of the vast reserves of world-class equity performance (this time disappointing) to shape engineers spread across emerging market countries. their expectations for the asset class. Indeed, continued Yet few would have expected that deepening capital relative strength of U.S. equities may have distracted markets and a growing entrepreneurial class could bring investors from the longer-term opportunity in higher- their talents to compete against industry titans today. growth parts of the world. We point below to some very Maybe it’s no surprise then that so many CES participants significant developments within the real economies of hail from countries that are considered emerging markets emerging markets that have continued unabated and that in the traditional, if outdated, taxonomy of investing, support a fundamental case for relative value in emerging including Russia, India, China, and Korea, among others. market equities going forward. The pace of change may have made it easy to miss the Figure 1: Growth of $1 in two different periods scope of the transformation that has taken place deeper December 1999 through April 2011 within emerging market economies. The first section of this paper reviews some of the major growth milestones, 3.5 $3.18 giving some context for how one might think about the 3.0 future investment opportunity this asset class offers. For us, it’s as much about the potential portfolio benefits 2.5 a strategic allocation can provide to an intelligently 2.0 constructed portfolio as it is about its attractive absolute return and risk expectations. We believe the most 1.5 Growth of $1 $1.32 significant gains await skilled investors who actively seek 1.0 $1.14 value and specific exposure to the growing numbers of unique and attractive businesses that are poised for 0.5 leadership on the world stage. 0.0 2011 1999 2001 2010 2007 2002 2005 2003 2004 2009 Performance, perception, and reality: How 2006 2008 2000 did we get here? MSCI EM-ND MSCI EAFE-ND S&P 500 We think the period from 2000 to the present can be divided into roughly 2 distinct periods that have shaped investor perceptions of emerging market equities as April 2011 through March 2021 an asset class. A look back at the year 2000 can remind 4.0 us how a variety of developments—from China’s $3.57 pending World Trade Organization (WTO) admittance 3.5 to the fruition of a common currency and an expanding 3.0 European Union—would mark major milestones 2.5 supporting globalization of trade flows and investment. 2.0 These underwrote positive expectations and performance $1.61 Growth of $1 1.5 for the asset class throughout the ensuing decade, leading $1.38 to a market peak in April 2011. The top panel of Figure 1 1.0 shows how an investment of $1 at the end of 1999 would 0.5 have fared over the period. 0.0 In spite of its sensitivity to two brutal recessions 2011 2017 2012 2021 2013 2015 2014 2019 2016 during the period, the MSCI Emerging Markets Index 2018 2020 (Net) returned a cumulative 218%, dwarfing returns MSCI EM-ND MSCI EAFE-ND S&P 500 of developed markets, and attracting significant investor flows. In the next decade, however, continued Sources: MSCI and eVestment Alliance, December 31, 1999, through March 31, 2021. The MSCI Emerging Markets Index was launched high expectations for emerging markets were largely on January 1, 2001. Data prior to the launch date is back-tested data unrewarded. The bottom panel of Figure 1 shows that U.S. (i.e. calculations of how the index might have performed over that time period markets have reaped outsized benefits since, with U.S. had the index existed). There are frequently material differences between back-tested performance and actual results. Past performance—whether large caps achieving a cumulative 257% return through actual or back-tested—is no indication or guarantee of future performance. March 2021. This has made the 38% achieved in emerging 2 markets seem lackluster by comparison. In fact, aggregate gross domestic product (GDP) growth ($3.2 trillion); and the Nikkei 225 in Japan ($3.9 trillion), experienced across developing countries this century has for example. Emerging markets have become one of the been nothing short of miraculous. Emerging economies most important equity allocations in a representative accounted for 21% of global GDP in 2000. Today, their global equity portfolio. share of global GDP has nearly doubled to 41%, according to the International Monetary Fund (IMF)—an astonishing The underlying mix of economic activities taking place uptake considering developed market economies grew in the more established emerging markets has also only moderately over the same period. We would be evolved dramatically. A reordering of supply chains within remiss not to call out China’s outsized contribution. emerging economies has moved many labor-intensive, Prior to joining the WTO, its impact barely registered lower-value-added export sectors offshore to lower-cost in spite of well-publicized supply chain integration and countries and to frontier economies that are now stepping inward capital flows. Once merely a curiosity, China is now onto the first rungs of industrialization. Industrial policies the most important global economy by purchasing power in the larger, more industrialized emerging economies parity and by share of global merchandise trade (according have aggressively targeted high-value-added industries. to IMF data sets and the WTO’s World Trade Statistical Perhaps China has defined the practice. For example, Review 2020, respectively). In Figure 2, the visible kink its “Made in 2025” initiative is channeling capital into a upward in the trajectory of global growth corresponds to variety of enterprises that are expected to produce global China’s official integration into global trade. first-mover advantages in high-tech manufacturing and global networking. Many other development plans are Figure 2: Emerging economies are a growing percentage also choreographed and, therefore, telegraphed to market of global GDP participants to some extent. These signals can clue active 120 investors in on which companies stand to benefit or suffer Emerging markets Developed markets under various scenarios. 100 More deeply, the realignment taking place within certain 80 countries and among them, through integration, presents China enters WTO 60 powerful forces that investors can anticipate and that we believe provide attractive investment themes that apply to 40 a number of investment opportunities. One theme to call World GDP ($B) out in particular is prevailing demographic trends. These 20 vary regionally and are critical for investors to grasp to gain 0 confidence that the companies they own have the proper consumer strategies where they operate. We outline some 2012 1992 1984 2016 1996 1988 1980 2020 2004 2008 2000 of these demographic considerations in the next section. 2024E EM% 24 22 18 16 20 21 22 31 38 39 41 42 DM% 76 78 82 84 80 79 78 69 62 61 59 58 Demographics are key to understanding Source: IMF datasets as of April 30, 2021. the next leg of growth in emerging Periods beyond publication date are forecasted. markets Reflecting the strength and breadth of real economic Several emerging market countries in South Asia, the growth, emerging market equities have grown rapidly Middle East, Africa, and Latin America have young and in their importance among global capital markets.
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