Why EMs should be back on investors’ radars

While emerging markets (EMs) may have slipped off investors’ radars in recent years, one top analyst sees several conditions favourable to a resurgence of the asset class, which will capitalise on global monetary policy easing, decarbonisation initiatives and AI innovation.

Despite China’s stuttering economy and concerns over a tightening of US monetary policy, which have given cash assets a boost, EMs are likely to see a rebound, with investment returns already trending relatively closely with developed markets.

For Chris Iggo, chief investment officer, core investments at AXA Investment Managers, an improving economic backdrop and the prospect of lower US interest rates will likely see improved returns for EM investors.

EMs, he notes, already maintain a strong foundation for growth. As an asset class, they retain numerous economic and demographic advantages (including a predominantly young workforce), Iggo said, being critical drivers of overall global growth, accounting for 50.1% of global GDP in 2023, and 66.7% of global GDP growth in the prior decade.

Moreover, because of EMs’ geopolitical diversity, booms in certain regions can offset declines in others, with Iggo noting that some regions currently enjoying rapid industrialisation.

For instance, he noted India’s population rapidly growing middle class, and youthful, optimistic more spend-happy population, with more than 40% under the age of 25.

However, EMs have long been associated with “high risk, high reward” investing.

More recently, elevated geopolitical risks and rapid rise in US interest rates have left many developing economies struggling; as Iggo noted, a stronger greenback has upped debt levels while lacklustre global economic growth has also taken its toll on developing markets.

However, EMs have performed strongly in recent months, with the MSCI Emerging Markets index delivering a total return of 9% in the year to date, while over the same period, the MSCI World is ahead by 12%, despite laggard growth from China.

EMs have also managed to, in the main, largely weather global monetary tightening.

“Much of this is because countries have taken steps to fortify and reform their financial institutions and are benefiting from stronger policies and financial frameworks, notably in Argentina, Egypt, Ghana and Pakistan.”

EMs should also benefit from a likely easing of monetary policy in the US – with lower US interest rates raising the attractiveness of potential EM returns, whilst a weakening US dollar will provide more flexibility for central banks to pursue easier policies in EMs.

As Iggo noted, the International Monetary Fund (IMF) expects emerging market and developing economies to now grow by 4.3% in both 2024 and 2025, up from previous estimates of 4.2% – with the upward revision down to “stronger activity in Asia, particularly China and India

As well, he said, companies in India, China, Indonesia, Mexico and Saudi Arabia often enjoy increased revenues when developed market growth is strong.

“This not only has positive effects on these countries’ domestic economies but also provides support for direct investment into their equity and corporate bond assets.”

Further, the IMF found that in 2023, net capital flows into emerging markets, excluding China, recovered from a post-pandemic low to US$110bn, or 0.6% of GDP in 2023 – the highest level since 2018.

EM growth will also benefit from global ‘megatrends’ such as decarbonisation and the growth of artificial intelligence (AI), with higher demand for metals like copper and nickel, which are key components in clean energy and EV infrastructure, as well as AI driving up productivity in developing markets.

Growth potential is strong, but don’t discount EM risks

Emerging markets economies represent a significant – and still growing – part of the global economy, with potential for strong returns over the long term.

However, near-term risks remain. A second Trump term could see the re-emergence of protectionist trade policies. While, as Iggo notes, these would most likely be aimed at China, they may “have spillover effects through supply chains to other Asian countries”.

As well, global geopolitical tensions could intensify, including rising tensions between China and Taiwan, the Middle East and the ongoing Ukraine/Russia conflict.

“Financial fragility remains an issue too, particularly in sub-Saharan Africa and in Latin America. Climate change risks pose a long-term threat too with the potential for disruption to agriculture, trade and communities,” Iggo wrote.

Despite the risks, opportunities abound – and EMs remain well primed for returns over the long term.

Iggo concluded: “Right now, a plethora of value can be found and given the less-than-stellar run the sector has endured of late, emerging markets could now represent a potentially solid, long-term investment opportunity.”