The strongest opportunities in emerging markets may be found off the beaten path, but how can investors get access?
- The most exciting opportunities may be found away from index heavyweights such as China and Brazil
- Vietnam and Mexico, for example, are clear beneficiaries of supply chain restructuring
- Other smaller economies are using their commodity wealth to build strong economic foundations
Emerging markets appear to be finding favour with investors again, led by major asset managers such as BlackRock and Fidelity. However, the most exciting opportunities may be found away from index heavyweights such as China and Brazil, in smaller markets such as the Middle East, Vietnam, Mexico or Indonesia, which are on the right side of global trends.
The restructuring of supply chains is being felt across emerging markets. While the move by international corporates to diversify production is unlikely to put a significant dent in the Chinese economy, its will boost smaller countries. Vietnam for example, is the most obvious beneficiary of the China-plus-one strategy, picking up key manufacturing contracts from global companies such as Apple-manufacturer Foxconn.
Mexico is also a clear beneficiary of the trend to move production closer to home. Research from Fidelity suggests that the near-shoring trend could add around 25% to Mexico’s exports to the US, equivalent to USD$100-150bn. It suggests that nearshoring could be a significant tailwind as US companies build factors and support employment growth. This would support a range of industries, including manufacturing, heavy industry, logistics, real estate, and transport.
Equally, there are a number of markets using their new-found commodities wealth to diversify and improve their economies. Saudi Arabia, for example, has its $3.2 trillion Vision 2030 project, which aims to reduce the country’s dependence on oil. This is ploughing capital into infrastructure development and is already creating interesting investment opportunities in the region.
Indonesia has also used its commodity wealth to good effect. It has delivered a steady growth rate of 5%. It is a beneficiary of growing intra-Asian trade, and is seeing strong sectoral trends, such as rising financial inclusion and growing consumption.
The problem is that these countries are minnows in terms of index representation. Even Mexico is less than 5% of the MSCI Emerging Market index and is dwarfed by China (29.2%), Taiwan (16.1%) and India (14.3%). Fund managers have to be properly active and benchmark agnostic to build meaningful positions in these areas. Equally, the markets are often illiquid, so open-ended funds may not have the same flexibility. Frontier market funds will have higher weightings, but there are relatively few of them left.
Nevertheless, there are managers that recognise and invest in these high growth markets, particularly in the investment trust sector. Investors will need to look under the bonnet to ensure that their emerging market exposure incorporates these diverse opportunities, rather than being a binary bet on China.
