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When it comes to emerging markets investments, it’s all about location, location, location and that location? India.
This was according to the data on ETF funds by Franklin Templeton last week in London at their EMEA ETF: Emerging markets outlook event.
The change in which emerging markets are the most attractive could have massive implications for investment teams at insurers in the coming years.
“Foreign portfolio investments in Chinese equities cumulatively lost most of their gains [they had made] over the past 10 years percentage-wise since 2020,” said Marcus Weyerer, CFA, Senior ETF Investment Strategist, EMEA, at Franklin Templeton, giving a snapshot of where the emerging market was – and where it was heading.
“The emerging market macro environment remains supportive as the
macro surprise index continues to rise.”
The emerging market has, like other parts of the world, reacted strongly to the inflation event over the past two years and the responding interest rate rises by central banks to curb its rise.
For many, watching what the US Federal Reserve does over the course of the middle of this year is key to figuring where emerging markets will be headed in H2 2024.
“The sharp repricing of Fed rate cut expectations and the subsequent sell-off in US Treasuries have not changed our Emerging Market outlook: we maintain a slightly [underweight] stance on emerging market external debt and a neutral stance on external [versus] local debt,” said Guillaume Tresca, from Generali Asset Management in their May report on emerging market sovereign bonds. “The emerging market macro environment remains supportive as the macro surprise index continues to rise.”
They added that returns are still expected to be positive, but mainly driven by carry and a positive duration effect. “We therefore maintain a low beta exposure globally and favour relative value trades,” said the paper.
Franklin Templeton said they had three major themes to watch for with emerging markets in H2 – the US election, rate trajectories and the fragmentation of the market – with certain countries doing very well, others doing poorly, and further countries stagnating, which was the scene across Asia.
The world’s second largest economy has had no shortage of bad news for over the past few years, from the endless Evergrande saga and its flow on effects to the rest of the structural issues in China’s real estate sector, to US trade spats and reshoring trends, as well as the demographic time bomb that has become front and centre as the country’s population begins to fall.
“Sentiment [on China] has suffered,” said Weyerer, but it was improving. “It’s been relatively poorly performing, and US investors are wary – but European investors are not quite so nervous but still slow.”
"[China] is in a painful transition from an export driven economy
to a consumption driven one.”
An indication of these green shoots in sentiment were EPS growth numbers returning to positive in 2023 – an increase of 0.3% compared to -17.4% in 2022 – and the estimate for 2024 sitting at 1.2%, before a kickstart to double digits in 2025 and 2026’s estimates.
China has rallied ever so slightly, Weyerer said, but he warned there are often false springs in this “very volatile market”. “China hasn’t peaked,” said Weyerer. “But it is in a painful transition from an export driven economy to a consumption driven one.”
This would be difficult as there was a lack of trust in the government from consumers, but this could be helped with attempts at stabilising the property market, for instance, which should be a priority, he added. China’s authoritarian economic model also meant it was easier for the government to “turn the taps on or off” depending on what it wanted from the economy, Weyerer added, which would be helpful as “youth unemployment is at painful levels”.
“The outlook, however, is more important than the numbers,” he said.
One aspect that was also warned about was any impact from the US election, with Weyerer saying there were hard line views espoused from both candidates but for different reasons so “rhetoric will change but not the actions”.
The world’s newly-crowned most populous country is currently in the midst of a polarising election where Narendra Modi’s nationalist Bharatiya Janata Party (BJP) party is seeking its third term in power amid criticism of religious tension and cronyism.
However, the country’s economic development is undeniable – Deloitte has revised its GDP growth rate of 2024 from 7.6% to 7.8% in April on the back of strong numbers.
This has made it one of the biggest attractions for those involved in emerging markets as its breakneck growth mirrors the China of 20 years ago before the never ending ‘slowdowns’ affected it.
The main growth drivers in India, according to Weyerer, were its infrastructure development – physical infrastructure such as new highways and air travel as well as import/export facilities – and digital transformation particularly around digitisation. This included increasing internet connectivity and consumers using smart payment options.
Other digital transformation drivers included the use of artificial intelligence (AI). Weyerer specified that Indian companies use of AI was at 60-70%, which was very high and twice that of countries such as Spain that were the laggards on AI.
Other drivers were Free Trade Agreements (FTA) being signed. India signed an agreement with a group of four European countries that are not members of the European Union – Norway, Switzerland, Iceland and Liechtenstein – in March.
The deal with the European Free Trade Association (EFTA) will see investments in India of $100 billion (£77.8 billion), the country's trade minister says. However, a post-Brexit FTA between India and the UK has largely stalled. It is also currently in negotiations with Canada and New Zealand.
The former has been complicated by the accusations by Canada that the Indian government was responsible, or at least involved, with the murder of a Sikh activist in Canada in 2023. Some reports said it had been suspended - which could show some issues with India, such as political volatility.
“Asia has 86% of the next billion entrants into
the global middle class."
The final driver was supportive government policy. For instance, renewables are growing at a faster rate in India than in any other major economy. “We’ve seen significant issuance from green energy suppliers,” said MacKay Shields in a post last year for Insurance Investor. “India is seeking to meet 50% of its energy needs from renewables by 2030 and is targeting net zero CO2 emissions by 2070.”
As mentioned earlier, China’s falling population and India’s rise to number one was also a key driver for its attractiveness with it receiving a ‘demographic dividend’. “Asia has 86% of the next billion entrants into the global middle class,” said Weyerer, emphasising the spending power increases that will occur here in areas such as real estate, healthcare, cars and consumer wares, retirement savings, and education.
Other countries that could see these style benefits included Malaysia and, to a more limited extent, the Philippines and Indonesia.
China, on the other hand, had multiple demographic weaknesses such as the effects on its long-run growth, which is determined by three factors – demographics, capital deepening, and productivity – all of which were decreasing. Taiwan and South Korea also saw issues to a more limited extent in this with Thailand seeing a mix of negatives and positives.
India’s attractiveness extended into other areas, too. In 2002, Fidelity said that “India is also set to take over China’s mantle as the factory of the world”, with manufacturing’s share of the national economy set to rise from under 16% to 21% by 2031.
On the wider investment trends, Lotfi Ladjemi, ETF Distribution – UK at Franklin Templeton, said that, “broadly, there is nothing but improvements in attractiveness of emerging markets.” “Growth is the reason why and may have been historically underrepresented or under-allocated, but this legacy is changing.”
He added that UK equities were “not doing particularly well”, so some of the home bias previously seen has faded away and that there was also more pressure around diversification as a key reason for growth in emerging markets and that this would have a continuing effect on their attractiveness.
“Emerging markets is getting a much more structured view
compared to how it used to be.”
“Allocations to countries without the same problems [that are seen in the UK and Europe] just makes sense,” he said. “ETFs just lends itself to emerging markets.”
Weyerer specified some of the reasons for the changes and renewed attractiveness of emerging markets were largely down to structural growth trends and an increasing importance as the diversification and economic growth showed more promise. “Emerging markets is getting a much more structured view compared to how it used to be.”
