According to MSCI indexes, emerging markets (EMs) achieved long-term returns in excess of those achieved by developed markets for the 10-year period ended 31 December 2012. Since 2000, emerging markets (measured by the MSCI EM Index) have outperformed developed markets (measured by the MSCI World Index) 10 years out of 12.2. The 2008 under-performance followed a period of notable relative strength, and that of 2011 reflected a particularly high level of equity issuance in record is based on what have been much higher rates of historical economic growth in EMs when compared to developed markets.
We think this trend could continue. According to the Economist Intelligence Unit, economic growth in EMs as a whole in 2013 is estimated to be stronger than in 2012, with Asia the fastest-growing region, followed by Africa, Latin America and Europe.3 In addition, EM countries as a whole are estimated to show faster growth than the developed-market group of countries.
We have continued to find attractive investments even in the slower-growing EM regions. The underlying potential from economic growth is reinforced by strong public and private finances, as measured by EMs foreign currency reserves that have exceeded those of developed markets. Additionally, debt-to-GDP (gross domestic product) levels in EMs have been substantially lower than in developed markets, and these levels have been falling, not rising. In spite of the strong fundamentals in EMs in recent years, their equities currently trade on a lower valuation as measured by price/earnings ratios and dividend yields, compared to most developed-market equities.
Commodity stocks performance, in Asian markets as elsewhere, has been subdued in recent quarters following several years of strength. We believe that the boom in many commodities may have run too far in the short term, leading to the current consolidation. However, we continue to believe in longer-term prospects for commodities due to the level of economic growth in EMs.
The Potential of Asia
Asian EMs stand out within the EM universe for their significant growth opportunities. The region has seen strong growth since 1999, even in 2009, when many developed markets were in recession. We believe prospects for GDP growth should remain far stronger in these markets than in many developed markets, and growth in Asian EMs could remain in excess of some other EM regions.
Asia’s demographics appear favourable, with many young people entering the work force, whereas in the developed world the proportion of the population at or nearing retirement is rising quickly. These advantageous demographics could have particular significance for consumer sectors. For example, as Asian consumers grow wealthier, so will their demand for passenger cars. Per capita car ownership in huge markets such as China and India is a fraction of that in developed markets. We believe that bringing car ownership in these markets up to US levels could require the production of almost a billion cars, indicating enormous potential.
The Chinese property market has some investors worried about the potential impact of an oversupply of high-end property in larger cities. We believe that the problem is isolated to few markets where prices have been pushed to unaffordable levels, while demand for affordable housing remains robust. In the longer term, rising wages in China and migration to the cities are likely to help clear the oversupply, and some niche property companies could represent attractive value.
Thailand and the Philippines were among the first Asian EMs to become available to foreign investors and both remain interesting. Both markets saw difficult times and considerable volatility due to natural disasters and economic and political upheavals, but both have made rapid progress. Thailand offers many investment opportunities, and past volatility provided opportunities to accumulate positions when other investors were selling. The Philippines is also on the rise, with the development of a major entertainment complex in Manila boosting a buoyant tourism industry and high remittances from overseas supporting the national finances.Frontier Markets
Frontier markets present a major investment opportunity. Many of the themes that apply to EMs: strong growth, low valuations, and relatively strong public and private finances, apply even more strongly to frontier markets. As of 2010, nearly 20 per cent of the world’s population lived in frontier markets, yet they represented under 6 per cent of the world’s GDP. We believe that this gap will close in the coming years, allowing frontier market to enjoy a continuation of growth rates that are stronger than those seen in many emerging markets. Levels of debt in frontier markets (public and private) are very low, which provides a significant measure of financial security in the event of macroeconomic turbulence, and a major source of growth potential for regional banks. We regard Africa as a particularly exciting region within the frontier-market universe — the continent boasts over a billion, mostly youthful consumers and some of the fastest GDP growth rates seen anywhere in the world in recent years.
Investment opportunities in frontier markets are abundant, in our opinion, with thousands of available companies within the asset class representing an overall market capitalisation in excess of $1 trillion and daily market turnover in billions of dollars, according to our calculations. A number of companies quoted in developed markets carry out a very high proportion of their business in emerging and frontier markets, which can provide an additional means to gain frontier-market exposure.
In addition, many of these markets are learning the importance of good corporate governance to attract high-quality funds. Within the large universe of frontier-market stocks, our strong, locally based research teams are able to find many attractive and well-managed companies.
Furthermore, from the perspective of asset allocation, frontier market investment might actually help reduce overall portfolio risk. Compared to the correlation between EMs and developed markets, frontier markets have shown significantly lower levels of correlation with each other, with EMs, as well as with developed markets. Hence, a sudden fall in one market can have less of an impact elsewhere, and the influence of global macroeconomic effects or sharp global market moves could be dampened.
(Mark Mobius is Executive Chairman Templeton Emerging Markets Group and Allan Lam, is Senior Executive Vice President, Senior Managing Director, Templeton Asset Management Ltd)
