- Investors are betting that China and other Asian countries will continue to be the engine of the global economy.
- Emerging markets’ medium-to-long term growth prospects are indeed significantly better than those of most developed markets.
- Provided investors don’t overlook the risks, they can benefit in the long term from emerging markets’ return potential, which is significantly higher than that of Western industrialised nations.
Dearth of emerging markets in portfolios
Emerging markets are particularly underrepresented in many portfolios. These markets are developing countries that are already engaged in the process of economic transformation and are thus experiencing high economic growth. They are, so to speak, on the threshold of becoming industrialised nations. Emerging markets are mainly found in Asia, but also in Central and Latin America, as well as in parts of Eastern Europe.
Several factors currently play into emerging markets’ hands. First, there are economic conditions, with EM proving to be the engine of the global economy. Many EM -- China, whose share in the index is very high at 39 percent, above all – implemented strict measures to contain the spread of coronavirus. This enabled politicians to loosen economic and social restrictions at an early stage such that industry could quickly recover from the slump.
Dynamic growth in Asia
DWS economics experts recently raised their growth forecast for[1] China from 8.2 to 8.7 percent. The other emerging markets in Asia are also expected to grow at an above-average rate of around eight percent.
"At the beginning of a global economic upswing, stock markets in emerging markets initially record only moderate gains,” says Sean Taylor, who has managed the DWS Invest Global Emerging Markets Equities fund since 2014. “If the upswing proves to be sustainable, however, investors' risk appetite also increases and capital flows into emerging markets."
Through its "Made in China 2025" plan, the Middle Kingdom is striving for technological leadership in important industrial sectors.
Another factor driving equity valuations upwards is a rapid recovery in commodity prices due to demand for crude oil and industrial metals increasing as the global economy picks up. This favours commodity-exporting emerging markets such as Brazil, Russia or South Africa.
Finally, we should not forget that China in particular has been developing from the "West’s extended workbench" into a technology hub. In its "Made in China 2025" strategic plan, the Beijing government has announced that its goal is to develop ten domestic industries into global technology leaders. This [2]technological connection to industrialised nations should further stimulate equity growth potential in China.
US dollar uncertainty
A critical factor for emerging markets is the US dollar’s trajectory. If the US dollar strengthens, this tends to be bad for emerging markets, as they often have high dollar debts. A strengthening US currency increases their debt burden and puts pressure on their own currencies. However, there have been signs recently that some emerging markets’ dependence on the dollar's performance has lessened. This is because their economic indicators have improved and their currencies no longer fluctuate as much as they once did, which is positive for investors. Investors considering allocating to EM equities should consider the risk of setbacks in the fight against the pandemic, as well as exchange-rate risks. Neither should investors ignore political risks. Turbulence of the sort seen recently in Turkey after the surprise ousting of the central bank head and the smouldering trade conflict between the USA and China could erode confidence in emerging markets.
Experienced fund managers bring benefits
Huge economic, social and political differences in emerging markets make it difficult to select the right equities. Fund solutions such as the DWS Invest Global Emerging Markets Equities fund can help. Experienced fund managers monitor market idiosyncrasies and react to changing market conditions. This allows EM equities to develop their return potential as an additional strand in a well-structured portfolio without investors having to take on too much risk.
