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By Andrew Ness, Franklin Templeton Investments
(Sponsor content)
The COVID-19 pandemic has tested health systems, social and economic structures throughout the world this year. Global financial markets took a hit during the severe downturn last spring, and emerging markets typically bore the brunt of negative sentiment as investors sought safety above all: first to be abandoned and slower to recover.
Over the past six months, a renewed appetite for risk has brought investors back to emerging markets. But as the second wave of the pandemic takes its toll on economic activity over the next few months, will they stay?
Defying stereotypes
Historically, emerging markets have been lumped together at the far end of the risk/reward spectrum, outperforming developed markets in good times but substantially underperforming in bad. The perception of unpredictable politics, unsatisfactory governance and unhealthy levels of debt has lingered since the 1980s. This misperception attracts speculators who ride the market up, make a quick profit and sell off just as quickly.
We would argue that this is a mistake. From our vantage point as veteran investors ― not speculators ― in the emerging markets, we see that traditional perceptions and today’s realities do not always match up. Closing the gap reveals long-term growth opportunities in resilient, but less familiar, businesses.
Which one is the mature market?
Emerging market businesses have evolved from the early days, when opportunities were limited and difficult to access, and the years when successful companies were primarily tied to the commodities boom. Today, companies domiciled in emerging markets are increasingly at the leading edge of technology and innovation. Corporate governance has improved, and global accounting standards have made company finances more transparent. Greater re-privatization and allocation of more private capital are signs that investors are making more long-term commitments to these markets.
No one has a monopoly on entrepreneurship, and as the pandemic has starkly revealed, some “developing” countries are proving more resilient and better able to manage the pandemic than their ostensibly more developed counterparts.
Emerging markets are not monolithic
While countries like China and India offer a large opportunity set, smaller nations such as Korea, Taiwan, Mexico and Malaysia also harbour great opportunity and have proven their resilience during the pandemic. For example, glove manufacturers in Malaysia have recently seen a dramatic surge in demand, driven by COVID-19. We believe it is important to keep an open mind and cast a wide net.
Emerging Asia, the first area to experience the pandemic, may also be the first to recover. In the last quarter, for example, stocks in China rose as its economic resurgence gained pace, with industrial production and retail sales beating growth expectations in September. Strong corporate earnings led Taiwan’s market advance and robust technology exports contributed to that economy’s third-quarter rebound. In Indonesia, the government relaxed coronavirus curbs in Jakarta and passed a job creation law aimed at reducing regulations and boosting investments: all in the space of a single quarter.
Beyond the pandemic
As the prospect of a vaccine providing immunity to COVID-19 grows brighter, those with a longer-term vision are looking beyond the pandemic to economic recovery and opportunities for meeting other global challenges: climate change, overpopulation, disappearance of habitat and biodiversity, among others. We think emerging market companies will be an integral part of the solution.
US equity markets outperformed emerging markets by a large margin over the last few years, but emerging markets have room to catch up. Market valuation of such companies is always a combination of the existing, slightly mature businesses and the new, evolving businesses. In our view, the market is not paying full value for many of them; valuations are discounted about 30% compared to developed markets.
When investors look beyond their home markets to companies based in emerging nations, they are likely to find:
- Higher cash flow for shareholders. As a percentage of overall market capitalization, emerging market companies now generate higher levels of free cash compared to the West.
- Domestic and regional growth opportunities for businesses. Consumer spending has risen, and economies are healthier in some emerging markets.
- Cash reinvested in the business. In the West, we see private equity firms taking over companies, leveraging them and pulling cash out. This use of debt is happening to a lesser extent in emerging markets.
- A firmer financial footing than during previous financial crises. Companies sitting on net cash balance sheets (e.g., technology firms) are now more financially and operationally resilient than in prior decades, such as the Asian crisis in 1996 or the Argentina and Brazil crisis in 2000.
Companies with positive cash balances have the resources to do the research and development that will help future-proof their businesses. In our view, emerging market economies have the resilience to deal with change: not only with current economic conditions, but also with the long-term secular changes that will reshape our world and our lives in the years ahead.
Andrew Ness, CFA, is a Portfolio Manager with Franklin Templeton Emerging Markets Equity, based in Edinburgh, U.K. He is the co-manager of Templeton Emerging Markets Fund. For over 40 years, Templeton Emerging Markets Fund has been investing in stocks of companies based or primarily active in fast-growing developing markets worldwide. This high-conviction portfolio includes developed market-domiciled multinationals as well as locally based businesses in emerging market countries and regions. Prior to joining Franklin Templeton in 2018, Andrew was as a Portfolio Manager at another Edinburgh-based asset manager. He holds a B.A. in Economics and an MSc in Business Economics from the University of Strathclyde in the U.K. Andrew is an Associate Member of the UK Society of Investment Professionals and a member of the CFA Institute.
Franklin Templeton’s Global Investment Outlook is online today (Tue. Dec. 1) at 11 am EST in English and on Dec. 2 in French at 1 pm EST. Anyone is welcome to attend by registering in advance here:
