Emerging markets will survive even if the category fades
Emerging markets, as represented by the Morgan Stanley Capital International Emerging Markets Index (MSCI-EM), have underperformed developed markets (MSCI-DM) for more than 10 years now. Unadjusted for risk, the performance of the MSCI-EM, since its inception a little over 30 years ago, is now the same as that of the MSCI-DM over the entire period. During the 1980s, the term “emerging markets” was coined by Antoine van Agtamael of the International Finance Corporation to suggest “progress, uplift and dynamism” as opposed to the stagnation that characterized the “third world”, a term that fell out of favor. As the MSCI notes, “an avalanche of political and economic events, including the adoption of market-oriented policies in China, the collapse of the Soviet Union, the spread of democracy in Eastern Europe and the fall of apartheid in South Africa, led to the rapid expansion of the universe of emerging markets throughout the 1990s. “Brazil was added in 1988, South Korea in 1992, the India in 1993, China and Taiwan in 1996, and Egypt in 2001. The EM index started with 10 countries representing around 1% of the global stock index in terms of market capitalization. Today, the MSCI-EM comprises 27 countries, representing almost 13% of the global stock index, which means a steady increase over the past three decades.
The top five countries in terms of market capitalization in the MSCI-EM index are China (34%), South Korea and Taiwan (just under 15% each), India (around 10%) and Brazil (5%). The top five companies are Taiwan Semiconductor, Tencent, Alibaba, Samsung and Meituan. South Korea, Taiwan, and China have long exceeded the World Bank’s definition of emerging market economies (defined today as those with an annual per capita income of $ 4,095), as have smaller countries like Israel. and Saudi Arabia. In the 1980s and 1990s, the largest source of portfolio investment in these markets came from large defined benefit plans run by American companies, such as the General Motors and IBM pension funds. Today, the most important funds are sovereign wealth funds, like those of Abu Dhabi and Saudi Arabia, index funds like those of Vanguard and Blackrock, Canadian defined contribution pension plans, like the CPPIB. and the CDPQ, and US government funds like CALPERS.
In the same way that an avalanche of changes led to an EM revolution, an equally large body of changes over the past two decades avoids this classification. With economic power now shared between the United States and China, most major investors are now deeply involved in these markets by investing in listed stocks, private equity, venture capital, debt and debt. immovable. Large Canadian investors like CPPIB and CDPQ now have a physical presence in Asia and make direct investments in specific companies in China and India, often co-investing with major global private equity players. For example, CPPIB recently invested $ 800 million in Flipkart Group and CPPIB, CDPQ and Singapore CPG together own over 10% of Kotak Mahindra Bank. The CPPIB’s plan to increase the Asian allocation to one-third of its total fund by 2025 aims to focus on investments in Australia and Japan, Greater China, India and South Korea. South. Large investors are likely to follow a country and / or sector specific strategy in large economies. Small investors are likely to follow opportunistic allocations to companies or countries.
However, the long period of underperformance of the EM Index has reduced relative valuations to attractive levels. In a post-pandemic world, as emerging market central banks have opened their liquidity taps, the immediate path forward for the relative performance of emerging markets looks good. Unsurprisingly, they have attracted attention and allocation swings to emerging markets are a clear trend in 2021. Against a theoretical allocation of 13% (based on index) or 37% (based on domestic product gross), the real allocations of MEs still remain low, in a range of 6 to 8%. While we may see investment in the upper end of this range for a few years, emerging market allocations are expected to level off at single digits and then gradually decline over the next several decades.
The narrative of a globalized world moving into a rules-based world for world trade defined by the World Trade Organization, which formed the basis for the steady march of emerging markets from 1988 to 2008, has been eroded. In a post-pandemic world, preoccupied with the implications of climate change, country, asset class and industry or even company specific strategies are likely to trump cue-based ideas. .
The idea based on an emerging market index will gradually fade. In the years to come, it may not be unusual to see allocation frameworks for global investors that read: “The United States, Greater China, Japan, Europe (y including United Kingdom and Switzerland), South Korea, other Asian countries and others “. with a sector framework for financial services, consumer products, technology and biologics / healthcare, creating a kind of country / sector matrix. This matrix allocation approach could appropriately address the dominant global companies in each sector. For India, over the next few decades, this will be a chance to shine individually and not a small part of a small allowance basket.
PS: To paraphrase Victor Hugo, even the most powerful cannot prevent the death of an idea whose time has passed.
Narayan Ramachandran is President of InKlude Labs. Read Narayan’s Mint columns at www.livemint.com/avisiblehand
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