Time to rethink traditional thinking in emerging markets

The external environment affecting emerging markets (EM) has materially changed in recent years, with slowing global growth and tightening financial conditions creating a more challenging backdrop. For some, this only confirms the perception of EM as a purely short‑term, tactical allocation—offering potentially high returns, but at a cost of heightened risk and volatility. However, this traditional thinking no longer fairly represents today’s emerging markets, highlighting the need for a more granular approach to investing. While the global backdrop has become more challenging, it also serves to highlight the broad and differentiated nature of emerging markets, as fundamentally well‑anchored countries diverge from weaker counterparts. In this article, we address some of the ongoing myths and misconceptions surrounding emerging markets and the potential investment opportunities this presents for adept, active investors.

Emerging markets make up a significant part of the world. While definitions vary, the International Monetary Fund (IMF) currently classifies 162 countries as emerging or developing economies and 41 countries as advanced economies^.1 This makes for a fertile investment landscape, offering wide variation in economic cycles, fundamental drivers, and market influences. The old view of EM as a tactical investment—best avoided during periods of global market or economic uncertainty—not only underappreciates the sheer scope of investment opportunities, it also fails to understand how significantly the EM universe has evolved in recent decades. Understanding the universe in detail, and the nuances that exist between countries, assumes even greater importance when one considers the still relatively scarce level of analyst coverage.

Myth 1: Slowing global growth means avoid emerging markets 

The playbook for investing in emerging markets has changed, with decisions no longer predominantly driven by the stage of the global economic cycle. Where once an expanding global economy, strong commodity prices, and moderate monetary conditions might have been seen as prerequisite conditions, the increasingly domestically driven nature of many EM economies means they are much less dependent on external factors. While these are still influential, they are part of a broader mosaic, alongside fundamental influences at country, sector, and stock‑specific levels. Today’s EM landscape, therefore, demands a more granular approach, and country‑by‑country expertise, as broad EM generalizations become increasingly tenuous. In addition to differences by country, EM offer a varied menu of assets to invest in, including hard currency sovereign and corporate debt and local currency debt, as well as deeper, more mature, equity markets. 

The external environment has also materially changed in recent years, and the steep increase in developed market interest rates, particularly in the U.S., is set to persist for longer than initially anticipated. The impact of this policy tightening is being felt disproportionately across emerging debt markets, with a clear division opening up in the landscape. On one side is a group of countries, including Mexico and the larger economies in South America (e.g., Brazil, Chile, Peru, Colombia), that are underpinned by robust fundamentals. This group continues to be able to access credit markets, and spreads have remained reasonable and relatively stable. 

On the other side is a set of fundamentally weaker EM countries that, as a result, are finding credit markets increasingly closed off to them. In the decade prior to the coronavirus pandemic, when global base interest rates were close to zero, many EM countries were able to access international capital markets for the first time, issuing new bonds at manageable spreads and with relatively low risk of default. Today, however, with base rates close to 5.5%, these countries are simply unable to issue new bonds at spreads that are sustainable. With no access to the market, they are struggling to refinance debt nearing maturity, and many have either defaulted already or are at risk of doing so. 

Similarly, on the equity side, we are also seeing the EM universe split along fundamental lines, with three groups emerging, namely: (i) countries that continue to deliver solid growth rates (south/Southeast Asia and some parts of Africa), (ii) countries where growth is structurally slowing (north Asia), and (iii) countries where the picture remains mixed and a wide range of outcomes are being seen (Latin America and central Europe, the Middle East, and parts of Africa). Once again, through detailed research and a good understanding of regional and country‑specific dynamics, it is possible to find fundamentally good businesses at potentially distressed prices. 

 

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