Some still view emerging markets as traditional commodity-oriented sectors. Have new business drivers changed that?
In the last 10 to 15 years, emerging markets, at least in the equity world, have changed so much. For example, when emerging market economies were really booming in the early 2000s, literally 40% of companies in the EM equity indices were financials, like large banks, and probably another 30% were commodities. But today, there are massive new industries. For example, China's first modern internet company did not exist 15 years ago. Now, if you add together the valuations of even just the internet sector in one emerging market country like China, you probably get close to $2 trillion. If you look across other sectors and other countries, the same story repeats where they never had these e-commerce, internet, software or fintech companies.
Today you see a lot more innovation with biotechnology and service companies popping up everywhere in many emerging markets. They are moving up the value chain and, in many cases, out-executing the developed markets and multinationals and really coming into their own. So the emerging market universe has changed massively and will continue to change going forward. I think this is good for investors because many of these newer companies and sectors are fundamentally going to be faster growing and probably a bit less cyclical.
How do you see the Covid-19 recovery unfolding in emerging markets?
Reshma Kapadia: I think it’s very different considering we haven’t really dealt with this type of pandemic affecting the global recovery. China, of course, was the first to experience the pandemic and has been the first to kind of get out of it. But, in the past, China’s recoveries often boosted the rest of the world. This time around, China has not had the type of stimulus binge we’ve seen in Europe and the US. So I think China’s recovery has been domestically driven and we haven’t really seen as big an export boost to the rest of the world.
More broadly, this is a very uneven recovery. China got back to sort of pre-pandemic growth last year and was the only major economy to do so. The International Monetary Fund (IMF) has come out and said many countries are not going to get back to pre-pandemic growth levels until 2023. So countries like India, where the expectation was for sort of a very sharp, V-shaped recovery, are now reassessing that situation. And in Africa, there’s a major challenge going on with vaccine deployment so we’re going to see that recovery take longer.
Many investors believe emerging markets are not innovative. What are your thoughts?
Mike Tian: You can think about innovation on two different axes, so to speak. One axis is business model related. I think EM companies are very strong in this respect – far stronger than they’ve been in the past and stronger than multinationals. Multinationals have been gradually pushed out of a lot of emerging markets in many sectors like industrials, technology, and consumer products because EM companies can tailor their products and services and business models to local conditions much better. They are launching services at an incredibly fast speed and tweaking them as needed to serve the consumers’ needs and doing it on a huge scale. All the world’s EM companies are very, very good at that.
But on the other axis, they are lacking on basic research. For example, if you want to create the next amazing oncology drug you probably won’t find that in emerging markets. Things like the quality of university educations and government support are still, by and large, stronger in the US, Europe, and Japan. EM countries are catching up, but it’s going to take a long time for them to match developed market countries.
What are your views of corporate governance?
Reshma Kapadia: I think this is a perception that has been out there for a while – and there has been reason for investors to have it. But, if you think about the environmental, social, and governance (ESG) movement, for example, we are seeing it play out in emerging markets too. It’s not just a US or European phenomenon. Over the years, especially in places like China, there have been marked improvements in terms of governance and the way they treat shareholders or think about things like sustainability. If you think about luxury shoppers in China, many of them want to see sustainability in their products. So it’s not impossible to find ESG-oriented companies in these places.
I think the bigger issue, however, is that even if you have strong governance, there is still the behavior of the government. So in China, with companies like Alibaba and Tencent getting ensnared in some of the anti-monopoly measures, it does raise questions for investors. I think the other risk is that as US/China tensions ramp up, some people think that China exposure could be a little bit like fossil fuel exposure in people’s portfolios. So there are lots of questions out there for investors.
What investment opportunities are you seeing in Latin America?
Mike Tian: I think Brazil is a very interesting country. Historically, it is considered a commodity economy, and that’s still true today. But I think to a lesser extent than it was before. The macro environment, however, is quite challenging because they have accumulated quite a lot of debt. On the other hand, I see some signs that upstarts are kind of challenging the status quo and there is a ton of innovation down there. There’s a lot of foment in many areas of the Brazilian economy. So I’m hopeful there are going to be some pretty interesting targets down there over the next five years.
How might international trade and inflation be impacting EM countries?
Reshma Kapadia: On the international trade front, I think the Biden administration is taking a look at the phase one trade deal. Most people I talk to expect those tariffs to stay in place, at least for now. And there is bipartisan support for a tougher stance against China. This could mean putting certain Chinese companies on blacklists or export restrictions as we saw with Huawei. This could make it tricky for investors because it’s going to be harder for those companies to get around some of those restrictions.
As for inflation, obviously higher rates are not a good thing broadly for emerging markets and I think it could be a broad level headwind for the asset class generally. Inflation could be much more difficult for certain countries, like Brazil, who have fiscal situations that are not where they need to be at this point in time.
What’s next for emerging market countries?
Mike Tian: I don’t think there has ever been a more interesting or exciting time to be involved in emerging markets as now. Especially for a growth investor. I think we’re on the cusp of seeing emerging markets do more leapfrogging. Think about TikTok, which is really the first global internet platform to have emerged from the emerging markets as a base and transplanting those behaviors over to developed markets.
I think there is going to be a lot more to come, and not just from China but a lot of other places, too. There will be big ecosystems and business models built around these things, and then increasingly they will be transplanted to developed markets. So, if you are a developed market equity investor, I think it’s time to start looking to emerging markets for inspiration to see who is going to be the XYZ of the US. It’s going to be a really exciting thing to watch over the next decade.
WCM deeply analyzes the culture of a company before investing. How does that apply to the EM world?
Mike Tian: I think there are certain things that translate very well and certain things that you really have to take the local context into account. The business culture in many of these countries is really quite different. For example, you have a South Africa, which is more like a developed market due to colonial heritage. Companies themselves are pretty old and professionally managed. How the regulatory apparatus works, how people think, how the boards function, how the companies behave – is more like the US or European management. Now, in contrast are India and China. In China, you have many founder-led companies, very young companies established in the 2000s.
The founder is often relatively young and has a lot of power – and actually has a much bigger imprint on the organization and culture of the business. And the things that a leader can get away with as “normal behavior” are very different in India versus China versus South Africa. For example, when you see a company treating employees a certain way, you have to think, well, is that normal for that country or does that stand out in a certain way. So as far as culture goes, you can’t take a box-checking approach and view everything the same for every geography. That’s why in China we spend more time understanding what the company and the founder is all about.