“Under-owned, underestimated and undervalued”: but could 2024 be the year emerging markets come good?

For more than a decade emerging markets have underperformed developed markets. With multiple elections set to take place in 2024 and a cooling of global inflation, could 2024 be the year that headwinds turn into tailwinds?

The average investment company in the Global Emerging Markets sector has produced a return of 70% over ten years. By contrast, the Global sector, which invests mainly in developed markets, has delivered 212%¹.  

Despite many emerging countries seeing healthy economic growth, the Global Emerging Markets sector has outperformed the Global sector in only two years out of the last ten (2016 and 2022).

Elections are taking place in 2024 in Taiwan (January), Pakistan (February), Indonesia (February), India (April/May), Mexico (June) and South Africa. In addition, the influential US presidential election is due to take place in November.

To understand how the elections could impact the investment outlook in 2024, the Association of Investment Companies (AIC) has gathered comments from investment company managers in the Global Emerging Markets sector.

Andrew Ness, Portfolio Manager of Templeton Emerging Markets, said: “We believe that 2024 has the potential to be a better year for emerging markets as the asset class remains under-owned, underestimated, and undervalued.

“Emerging markets are under-owned: relative to the MSCI index, investors are underweight emerging markets, and relative allocations have declined significantly versus ten years ago.

“Emerging markets remain underestimated – in many ways – macro resilience, quality of opportunity, technological leadership. For example, debt in developed markets is higher and rising faster than in emerging markets. Moreover, emerging markets are home to many best-in-class companies globally – growth stocks at value prices – driven by innovation, consumption, and commodity resource advantage.

“Emerging markets appear undervalued: relative to developed markets, the MSCI EM Index is trading at a discount of around 45% versus the MSCI World Index based on price to book value. Moreover, the MSCI EM Index P/E ratio is relatively low compared to the past decade.

“We take comfort from the fact that emerging market valuations are low, and investors are lightly positioned. As the late Sir John Templeton said, bull markets are ‘born on pessimism, grow on scepticism, mature on optimism and die on euphoria’. After more than a decade of emerging market underperformance, it is fair to say there are plenty of pessimists and sceptics out there. We are hoping 2024 challenges that view.”

Charles Jillings, Portfolio Manager of Utilico Emerging Markets Trust, said: “We are becoming increasingly excited by the prospects for emerging markets in 2024. Whilst some emerging market countries have already marginally reduced interest rates, further cuts are likely to come in 2024 as real rates in the majority of emerging markets are now typically positive, inflationary pressures are under control and these markets are becoming more robust to external shocks. With falling inflation and a weaker US dollar, emerging markets should be in a position to take full advantage of the global upswing in manufacturing activity that is anticipated to happen later in 2024 and into 2025.

In 2023, investor pessimism towards China was very high. While justified, in 2024 it is possible that China outperforms as it continues to ramp up monetary easing measures to revitalise its economy. President Xi’s recent and understated visit to the US, his first in six years, to meet with President Biden probably points to a renewed desire to improve relations with the West, prioritising the need to bolster Chinese trade and its economy over other longer-term geopolitical aims. All a much more positive backdrop for emerging markets in 2024.”

Adnan El-Araby, Co-Manager of Barings Emerging EMEA Opportunities, said: “The interest rate policy cycle has peaked across large parts of emerging markets and some central banks have already begun easing and we expect more to follow suit. The US dollar has weakened in recent months and the gap between emerging market and developed market GDP growth is improving – these should all act as tailwinds for emerging markets.

“For Emerging Europe, Middle East and Africa (EMEA) specifically, the Gulf Cooperation Council continues to benefit from low inflation, a steady momentum of capital investments, and high employment. We do, however, expect the price of oil to remain volatile for a variety of reasons (supply policies, global growth and geopolitics). Poland, post the election, has quickly become the country within emerging Europe with a standout economic outlook. The reform agenda from Turkey’s recently appointed economic team provides significant promise for prudent investors. In South Africa, whilst it appears that the impact of load shedding on company earnings is easing, the economic and earnings recovery remains elusive. Upcoming elections in the country could create uncertainty.”

Elections

Charles Jillings, Portfolio Manager of Utilico Emerging Markets Trust, said: “In 2024, 51% of the MSCI EM index (by weighting) faces elections. India, the world’s largest democracy goes to the polls in April 2024, and at this stage it is hard to see any outcome aside from a third term for charismatic leader Narendra Modi and his Bharatiya Janata party (BJP). BJP’s success is a reflection of pro-business flagship reforms which Modi has implemented over the past decade, including digitising the economy, investing in infrastructure, and new welfare schemes. These have combined to allow the country to flourish, evidenced by GDP growth hitting 7.6% in the September quarter. A continuation of Modi’s economic agenda will likely see additional opportunities arise and further investment into this remarkable country.

“In Indonesia, President Jokowi will end his second five-year term in February 2024, and he will leave as one of the most popular presidents thanks to his economic and social policies. The two main candidates, Defence Minister Prabowo and former Central Java Governor Ganjar Pranowo, are currently neck-and-neck in the polls and it looks as if it will to go to a run-off vote with the third candidate Anies Baswedan being eliminated in the first round. Pleasingly, both Prabowo and Pranowo have pledged to continue Jokowi’s signature policies, which is encouraging for markets and long-term prospects for this populous and resource-rich nation.”

Chris Tennant, Co-Portfolio Manager of Fidelity Emerging Markets, said: “The consensus is that Mexican President Andrés Manuel López Obrador (AMLO) will be replaced by ruling party candidate Claudia Sheinbaum, who currently leads the polls. This will have mixed implications for markets – on the one hand fiscal pressures could increase as Sheinbaum will likely not deviate from AMLO’s policies and social programmes. On the other hand, the elections could result in a more balanced congress, limiting the ruling party’s ability to make constitutional changes, and reducing the risk of policy intervention for companies. This could bolster our already positive view on Mexico, which benefits from a positive macroeconomic backdrop and the nascent trend of nearshoring as the US looks to shift its supply chains closer to its own borders.”

Andrew Ness, Portfolio Manager of Templeton Emerging Markets, said: “Overall, we don’t expect a major impact on the portfolio as most incumbents are expected to prevail, leading to policy continuity. Taiwan looks like the closest race with the incumbent DPP lead narrowing in recent polls. A DPP defeat, however, may lead to a softening in the rhetoric with China leading to, potentially, positive market consequences. Overall, little noise is expected from the emerging market electoral cycle. There is probably a bigger scope for volatility in key developed market elections (the US and UK) this year.”

Opportunities

John Citron, JPMorgan Emerging Markets Investment Trust, said: “We believe that China is focused on a sustainable growth trajectory, including removing tail risks from the real estate sector, of which there was more evidence in October 2023. We also think Chinese consumption should gradually recover over the coming year which, in turn, is supportive for earnings.

“Latin America has been ahead in the fight against inflation and we think falling rates should lead to improvements in economic activity, bolstering consumer sentiment and benefitting financials and consumer stocks.

“In EMEA, South Africa is beginning to see green shoots after prolonged weakness from power outages, while the Gulf states – which have become an important constituent of the emerging market universe – look set to offer a broader array of consumer related opportunities, as the region seeks to diversify from its reliance on the energy sector.

“While markets have certainly been more volatile, there are reasons to be more optimistic about emerging market equities including falling global inflation, which provides emerging market central banks room to cut aggressively, and a weaker US dollar. China’s economy continues to grow, though slower than expected. Valuations – currently around their long-term averages – are reasonable, and emerging market earnings offer upside potential. As always, we continue to look for opportunities in emerging market equities where earnings growth can compound over the long run.”

Prashant Khemka, Chief Investment Officer and Founder of Ashoka WhiteOak Emerging Markets, said: “Our investment approach is bottom-up with a firm belief that outsized alpha can be generated through superior stock selection. Certain segments of the markets are structurally more alpha rich, and consequently we end up having higher allocation to such areas of the investable universe.

“As an example, small and mid caps are an under researched and inefficient market segment, more so than large caps. We have equipped ourselves well with one of the largest teams of highly talented stock pickers in the industry to exploit these inefficiencies. The trust’s structure also allows us to invest pre-IPO where we apply our team’s expertise to identify and invest in opportunities a short while before their listing.

Besides small and mid caps, we also believe that better governed segments of the market present higher alpha opportunities than poorly governed ones. At the risk of generalisation, in our assessment weaker governance is more prevalent in markets with authoritarian regimes, amongst state-owned entities and in highly regulated sectors. As such, these segments have lower representation in our portfolio. On the other hand, our team finds a lot of attractive opportunities in countries with stable democracy, amongst entrepreneurially run companies in lightly regulated sectors such as consumer, financials, healthcare and technology.”

Andrew Ness, Portfolio Manager of Templeton Emerging Markets, said: “Our geographic positions have been consistent for some time, with key overweight exposures in South Korea and Brazil. This reflects the bottom-up opportunities in those markets.

“We still like the consumer opportunity in emerging markets and continued growth in domestic consumption allows us to invest in a wide range of companies and sectors – from staples and e-commerce to banks. Names held here include firms like Naver in South Korea, one of the country’s leading internet platforms – think of it as a mix of Google and Amazon. It is the country’s dominant search engine, with over 70% market share.

“Then there’s the opportunity to invest in emerging market leaders that are also powering the global economy. Names like China’s Guangzhou Tinci, the world’s largest electrolyte supplier for electric vehicle batteries. Electrolytes are one of the four key components in lithium-ion batteries – sitting alongside the anode, cathode and separator.”

Chris Tennant, Co-Portfolio Manager of Fidelity Emerging Markets, said: “We continue to see opportunities in the financials sector. We do, however, think that the boost that banks have had from rising net interest margins has largely played out, and are looking to shift the focus from higher-rate beneficiaries to those that benefit from structural drivers. These include structural growth stories like Indian banks, which operate in an underpenetrated market that should see rising demand for products like credit cards and savings accounts, and structural change stories like Greek banks, where a decade of very low loan growth has resulted in many banks with excellent asset quality.

“Looking to regions, we are particularly excited about Latin America. In addition to Mexico, which benefits from the nascent trend of nearshoring, the macroeconomic environment in Brazil is very strong. Brazil’s trade surplus is at record highs, and with inflation under control and interest rates coming down, we expect a positive tailwind for consumer and corporates over the next year. We have exposure to companies across Latin America, including beneficiaries of nearshoring in Mexico such as cement producer GCC, and railroad operator Grupo Mexico Transportes, while in Brazil one of our high conviction positions is Nu Holdings, a Brazilian digital challenger bank that is rapidly growing its customer base and taking market share from incumbents.”

Risks

Charles Jillings, Portfolio Manager of Utilico Emerging Markets Trust, said: “Inflationary pressures on food and energy prices could derail the downward trajectory of emerging market inflationary dynamics. El Nino is one pressure here. At present the full impact of El Nino is unclear, however any material changes in weather in 2024 could hamper regional agriculture yields thereby placing additional pressure on food prices which typically make up a higher proportion of CPI baskets in emerging markets. India is one country that is highly susceptible with 45% of its CPI basket being linked to food.

“Fluctuations in oil prices is also something that needs to remain on the radar. The current oil price of around US$80 per barrel is much more palatable to those emerging market countries such as India and Malaysia that are net importers of oil, however any material supply disruptions in 2024 or material increases in demand could put upward pressure on energy pricing which will then feed through to inflationary pressures.”

Adnan El-Araby, Co-Manager of Barings Emerging EMEA Opportunities, said: “Restrictive monetary policy could negate the soft landing narrative if inflation remains above target levels and central banks are forced to keep rates higher than the market expects. Over 40% of the world’s population will be voting in 2024, including the US, which will create known and unknown uncertainties.”

Prashant Khemka, Chief Investment Officer and Founder of Ashoka WhiteOak Emerging Markets, said: “Most of the risks facing emerging markets are the same as those facing the developed world. Front and centre at this time is the risk of escalation of ongoing geopolitical tensions or opening of some major new frontiers.

“Any reversal of the declining inflation trajectory due to unforeseen shocks to the world order is an economic risk which investors would be cautious of. Furthermore, several countries will be holding elections through the year, which may contribute to heightened volatility around the events in these markets.”

Chris Tennant, Co-Portfolio Manager of Fidelity Emerging Markets, said: “As the largest single market in the universe, China plays a central role in driving sentiment towards emerging markets. There remains marked weakness in the property market which has implications for both consumer confidence and commodity demand. In an environment where growth is likely to be weaker than it has been historically, and where demographics are worsening as the population ages, evidence that companies are returning capital to shareholders is critical. Valuations are attractive, however, and we are seeing growing number of Chinese companies buying back shares and paying dividends to shareholders.”

- ENDS -

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Notes to editors

1. Source: theaic.co.uk / Morningstar. Data to 2 January 2024.
2. The Association of Investment Companies (AIC) represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s vision is for closed-ended investment companies to be considered by every investor. The AIC has 341 members and the industry has total assets of approximately £260 billion.
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