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It has been an eventful ten years for emerging markets. Marked by the rise of China, political turmoil, seesawing commodity prices, but also growth and positive market returns, according to Jaap van der Hart, portfolio manager of Robeco Emerging Stars Equities.
New markets will come to the forefront, others may fade. Some regions will boom while others stagnate. As investors we have to be humble and keep looking for new opportunities while remaining alert to potential risks. This view underpins Van der Hart’s analysis in his white paper ‘A look at longer-term trends in emerging markets’.
Robeco Emerging Stars was launched as a freestyle variant of the company’s core emerging markets strategy in 2006. This means the portfolio is index agnostic and is a concentrated (high conviction) product. Van der Hart, who now co-manages the fund with Fabiana Fedeli, has been with Emerging Stars since its inception.
China has certainly made its mark in the emerging market universe in the last decade. As a result of growth and, to a greater extent, additions to the investable universe, the country has risen from fifth position in 2006, roughly equal to Russia and Brazil, to become the largest emerging market. Six of the top ten emerging companies are Chinese.
And there is probably still more to come according to Van der Hart. If restrictions and complications for foreign investors are smoothed out, the shares listed on China’s domestic markets could also qualify for MSCI inclusion. China could eventually form 40% of the emerging universe.
However, it has not all been plain sailing. Chinese debt has spiraled higher as the government has boosted spending to shore up GDP growth to meet its targets. Although a deficit figure of 3% of GDP looks reasonable, much debt is at regional and state-owned-enterprise level and if this spending is included, some estimate the figure at closer to 10%.
Although this pace of debt growth is not sustainable, there is not necessarily any immediate risk. But currency pressure and the less quantifiable and regulated shadow banking system remain a worry.
‘Sharp rise in debt arguably China’s greatest challenge’
The government may well be forced into accepting lower growth to reduce debt levels; managing this process effectively will be one of the Chinese leadership’s key challenges.
Another clear trend in emerging markets is the reduced emphasis on commodities. In his paper, Van der Hart comments that in the last ten years, commodity prices have fallen significantly and as a consequence the combined weight of the energy and materials sectors has halved to less than 15%. The weight of commodity countries like Russia has also declined, exporters now make up less than 30% of the universe. The fate of emerging markets is now far less tied to that of commodities. Perception still lags reality in this respect.
Looking ahead, which countries are in a position to follow China into the spotlight? Van der Hart sees India and Brazil as two markets with potential. Both still score poorly on the World Bank’s Ease of Doing Business Ranking and so there is certainly room for improvement.
‘India is the market with the best growth prospects’
India, headed by the Modi administration, is on the right track, with a brighter outlook for growth and reform. Brazil is not as far – the economy is still in a pretty poor state and there is little stability, but the new government does have reform plans.
A large group of countries could also join the ranks of the emerging universe. Pakistan is set to enter the MSCI EM Index in May 2017 and Argentina’s Macri government is embarking on reforms that also make it a likely candidate. Further down the line, frontier markets like Vietnam and Bangladesh could be the new rising stars as China becomes expensive and cheap manufacturing shifts elsewhere.
Politics has played a major role since the Emerging Stars strategy was launched. Investors have witnessed turbulent times, but should not forget the positive stories. Smooth transitions of power in Korea and Taiwan and a clean-up in Brazil. Van der Hart also emphasizes that recent political surprises have occurred closer to home – Eurozone issues, Brexit and Trump – demonstrating that political risk is not just an emerging market phenomenon.
Despite populism, global warming, low growth and even lower interest rates, the world has become a better place for many. Fewer people live in extreme poverty than ten years ago.
In terms of equality, there are less differences between the poor and the rich countries. Although progress is slow, education and health care have improved, and economic development will drive further growth and boost prosperity.
The fund’s strategy of maintaining risk diversification, flexible country selection and applying a stock selection process that looks for undervalued but attractive companies has proved successful.
In the last ten years, it has generated a gross annualized return of 8.7% (versus 4.5% for the reference index). Van der Hart plans to continue with what has proved to be a successful formula and to ensure that the fund is well-positioned to benefit from developments in the emerging world in the decade to come.
Read the white paper ‘A look at longer-term trends in emerging markets’, which gives a more in-depth look at the emerging market universe, the fund and its performance.