One of the main arguments for investing in emerging markets (EM) equities over the past 20 years has been the above-average economic growth in EM countries. Yet this growth advantage has begun to fade as EM policymakers have switched their emphasis in recent years. Rather than simply pursuing growth at all costs, they are now focusing on the broader goal of economic development, which is more concerned with the quality and durability of growth, along with greater social cohesion and environmental sustainability. This shift in emphasis is enhancing productivity and encouraging growth in new industries.
Yet markets tend to be better at assessing near-term dislocations (such as the impact of a sudden fall in the oil price on EM oil-exporting countries) than appreciating structural changes. I believe that understanding the structural changes associated with the emphasis on economic development will be key to tapping the potential of EM equities over the coming decades. Furthermore, our research indicates that EM stocks linked to development trends are less volatile, as they are driven predominantly by local policy and domestic demand and are less sensitive to global forces, such as trade sentiment and tariffs. Certainly, they have held up relatively well during the recent market weakness caused by political uncertainty, macro volatility and trade tensions.
In my view, there are four key forces of structural change related to economic development:
- Greater inclusiveness, broadening the range of beneficiaries of economic progress. This brings wider access to health care, education and sanitation, reduced inequality and improved life expectancy.
- Sustainability, as available resources are used with greater consideration for future generations and the environment. This results in improved recycling, water and waste management, energy efficiency, alternative energy sources and testing and diagnostics.
- Improved living standards, to ensure stable progress for the whole population. This leads to changes in how consumers spend their time and money.
- Enhanced productivity, increasing the efficiency of all available factors of production. This is evident in the use of technology, promotion of innovation, support for training/higher education and institutional reform.
These structural forces can materially impact a country’s prosperity, leading to a broader range of industries, greater innovation and knowledge sharing, a wider variety of goods and services and reduced inequality. Typically, they also result in deeper financial markets, with more listed companies, and a favourable environment for profitability ― and thus rich investment potential.
I believe that markets are underappreciating the political determination to make economic progress more stable and inclusive. For example, even as growth rates across EMs have slowed, we have seen continued increases in health care and education spending, the market share of renewable energy and access to electricity and clean water.
Consumers push for change
The move towards economic development is coming not only from policymakers but also from consumers concerned about environmental issues. This is particularly evident with climate change. Wellington has conducted analysis in collaboration with the Woods Hole Research Center, one of the world’s leading independent climate research institutes, on the expected increase in extreme heat patterns globally. The below shows the disproportionate impact on the emerging world. Regions in darker colours may suffer not only higher temperatures but also more severe droughts.
EMs are likely to suffer a disproportionate share of climate-related impact
Additional days per year in the danger zone
World based on the 1951 – 1980 reference period