Latest article

Finding value in developing markets

December 2020

  • Emerging markets have seen a significant economic hit from the pandemic
  • Many emerging markets are recovering quickly from the economic weakness, particularly corporate earnings
  • Reform is still a major driver for growth across emerging markets

Covid-19 has hit emerging markets every bit as hard as it has hit developed markets. While many have younger populations and therefore lower mortality rates, this has been offset by underdeveloped healthcare systems and constrained government finances. However, as the world starts to recover, emerging markets may have some natural advantages.

Like their developed market peers, emerging markets have seen economic damage from the pandemic. The figures, in many cases, make for uncomfortable reading. India, for example, saw its economy contract 23.9% from March to June. For Latin America, it was a similar picture. Peter Taylor, senior investment director on the Aberdeen Latin American Income fund, says: “We have seen shocking numbers in terms of economic contraction, reflecting the global economic slump that we’ve experienced across both developed and emerging markets.”

However, in many areas, there are clear signs of recovery. This is particularly true for Asia, where China’s rapid emergence from the virus has helped its economy revive, along with those of its neighbours. Gabriel Sacks, investment director on the Aberdeen Standard Asia Focus trust says: “There is an expectation that there will be a very sharp rebound for earnings going into 2021. There is likely to be around a 5% drop overall this year, followed by a 25% bounce next year.”

That said, the recovery is not just confined to those areas that have successfully managed the virus. In Brazil, one of the hardest-hit regions from the crisis, earnings are being revised higher. Taylor says: “The speed at which the Brazilian economy normalised gives us cause for optimism. Consumption, for example, rebounded faster than expected and we have seen this feed through into the earnings for consumer companies, which are being revised higher.”

Debt levels

In general, emerging markets have not taken on the same government borrowing as developed markets. Many have not had deep enough pockets, or the same unfettered access to international debt markets. This has limited their ability to spend. This may be a disadvantage in the short-term, but is potentially an advantage in the longer term as their economies aren’t weighed low by debt and they do not face the same cliff-edge drop as stimulus is withdrawn.

Emerging market companies also tend to be less indebted. Sacks says: “Companies are typically very disciplined when it comes to managing their balance sheets and capital allocation. Net debt to equity is a lot lower in Asia than it is developed markets.”

Reform

There are other considerations that should favour emerging markets. Reform is still a major driver in many economies. In India, for example, we see continued reform to tackle corruption, promote financial inclusion and digitalisation. Kristy Fong, senior investment director at Aberdeen New India investment trust, says: “The government’s commitment to reform has been very consistent. This is the government’s second term and they have put through very difficult reform measures, which will be great for India in the long-term.”

In Brazil too, there has been a continuation of the reform agenda under Jair Bolsonaro in spite of the disruptive impact of the pandemic. A number of reforms are currently under review in Congress, including a public sector reform bill to lower payroll costs and improve efficiencies; there are also plans to reform the complex and inefficient taxation system.

US election

The US election may also prove to be a game changer for some emerging markets. Firstly, a more stable and predictable approach to foreign policy should be better for everyone. While it is unlikely that President Elect Biden will fundamentally shift the US’s stance on China, he is likely to take a more measured approach.

Elsewhere, the advantages will be more apparent. Biden has a history of good relations with Latin America. Equally, the region may be a beneficiary of greater fiscal stimulus in the US, though the size may depend on whether Biden secures control of the senate following the election in Georgia in early January.

Sacks says: “We expect a Biden win to be good for emerging markets. A blue wave, where the Democrats won the Senate and Congress would probably have been better, but our expectation is that monetary policy and fiscal policy should remain loose, which should result in a weak dollar.” Taylor adds: “The most important thing is the end of uncertainty about the outcome. This creates a certain degree of visibility going forward.”

Valuations

Emerging markets also have more compelling valuations. While emerging markets have outpaced their developed market peers since the market turned in April, they had a long way to go to catch up. Over 10 years the MSCI Emerging Markets has delivered annual growth of just 2.4%, compared to 8.6% for the MSCI World. Equally, many of the early gains have come from China, which has left other emerging markets some way behind. There is significant scope to catch up.

That said, while this suggests a favourable backdrop for emerging markets, investors need to be active and to focus on quality. In this type of environment, the strong will get stronger. Fong says: “One of the opportunities we’ve seen is that in challenging times, strong companies get stronger as the weaker ones find it harder to survive.”

For more information, please visit our websites:

Aberdeen Latin American Income Fund Limited

Aberdeen New India Investment Trust PLC

Aberdeen Standard Asia Focus PLC

Important information

Risk factors you should consider prior to investing:

  • The value of investments and the income from them can fall and investors may get back less than the amount invested.
  • Past performance is not a guide to future results.
  • Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
  • The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
  • The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
  • The Company may charge expenses to capital which may erode the capital value of the investment.
  • Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
  • Property investments can take significantly longer to buy and sell than other investments, such as bonds and company shares. If properties have to be sold quickly this could result in lower prices being obtained for them.
  • Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
  • There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
  • As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
  • The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
  • Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
  • With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘sub-investment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
  • Yields are estimated figures and may fluctuate, there are no guarantees that future dividends with match or exceed historic dividends and certain investors may be subject to further tax on dividends.

You can also register for updates and follow us on Twitter and LinkedIn

Risk warning
Risk warning
The value of investments and the income from them can go down as well as up and you may get back less than the amount invested. Please refer to the relevant Key Information Document (KID) prior to making an investment decision. Please be aware of scams that can affect investors.