The underperformance of emerging markets versus global equities over the past three years has led investors to question whether their long-term prospects have changed.
The outlook for emerging markets is always evolving, but the long-term structural growth theme remains intact.
The long-term case for these markets centres on superior growth, quality companies, and the large set of diverse investment opportunities.
Superior growth
Emerging market growth is driven by attractive demographics, rising investment creating higher-paid jobs – leading to an expansion of the middle class – and rising consumption.
The United Nations (UN) projects the global population will increase by two billion people to 9.2 billion by 2050. The majority of the increase will be in emerging markets. While the global population will age, the working-age population will increase to 4.25 billion over the same period (Source: UN World population prospects 2022).
The middle class in emerging markets will also expand dramatically over this period as investment increases the demand for labour and more people move to cities. The urbanisation rate in these markets is forecast to increase from 51% to 66% by 2050.
As the middle class in emerging markets expands, demand for consumer goods ranging from autos and air conditioners to tourism will rise significantly. Auto penetration in emerging markets 2022 was 119 per 1,000 people, compared to 497 in developed markets (Source: International Organization of Motor Vehicle Manufacturers).
Quality companies
Emerging market companies with quality characteristics have increased over the past 15 years. The weight of new economy sectors, which includes companies with quality characteristics, in the MSCI Emerging Market index has increased to over 50% over this period. The weight of old economy, including low return on capital companies, has declined to under 20% (source: MSCI).
Diverse investment opportunities
Emerging markets are home to some of the most exciting investment opportunities including those in the electrification of transportation and the green revolution, such as renewable energy and battery storage systems.
These companies are the enablers of the fourth industrial revolution, which will focus on general-purpose technologies and artificial intelligence (AI).
South Korea is at the forefront of these trends. It is home to one of the world’s largest semiconductor companies, a sector that we think has a bright future. The country is also home to companies developing the next generation of batteries that are powering the green transition in electric vehicles (EVs).
A new global trade landscape
Supply chain worries and rising geopolitical tensions with increased focus on cutting-edge technologies including AI and advanced semiconductor production are contributing to a re-shaping of the global trade landscape.
This is leading countries to accelerate efforts to diversify their trade relations and protect their supply chains. The US, EU, and Japan are adopting a “de-risking” strategy by realigning their supply chains and strengthening bilateral relations with their allies.
We have identified countries such as South Korea, India, and Mexico as winners from this de-risking strategy. The list is by no means exhaustive, but we believe these markets offer solutions to developed market manufacturers to diversify their supply chains.
Why now?
At Franklin Templeton, we cite three reasons why now is the right time for investing in emerging markets, what we call the three “Us”. Emerging markets are 1) under-owned, 2) underestimated and 3) undervalued.
Investor portfolio allocation to emerging markets are below that suggested by the index weight; they are under-owned. Investors are underestimating the potential of companies in emerging markets, including those that could be at the forefront of the fourth industrial revolution.
The impact of these factors creates a significant opportunity as many of these companies are undervalued, or trading below their intrinsic worth from a valuation perspective.
Andrew Ness is portfolio manager of Templeton Emerging Markets Investment Trust (TEMIT)
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