Over two days in early March, our emerging market (EM) experts joined some of our institutional investor clients from across the globe in our London offices to reflect on a shifting global backdrop and share insights on how to navigate an uncertain future. Here are some of the key themes that were discussed.
The shift to a multi-polar world
Geopolitical risk has returned as a key consideration for asset allocators, with war in Ukraine accelerating the move to a multi-polar world, while also speeding up energy policy shifts. This does not herald an end to global growth, but it does signify that regional trading patterns are becoming more entrenched.
Latin America is benefiting from the shifting global backdrop, especially Mexico given its proximity to the US. Across the region, we’re seeing bilateral deals and strategic relationship building.
Cyclical divergence between China and US/rest of world and between regional groupings is likely to continue.
Weighing the EM investment case and fundamentals
The structural investment case for EMs remains intact. Global economic momentum is still shifting away from advanced western economies, and revenue growth remains correlated to GDP growth. Structural foundations in EMs are robust as evidenced by credible central banks and current account surpluses, among other factors. In EM sovereign debt, overall credit quality has improved significantly over the last 30 years, even with the entry of new frontier markets. Frontier markets are a highly diverse part of the opportunity set and a rich source of potential alpha.
In the sweet spot, with buffers
Thanks to proactive central banks, EM economies are now in a sweet spot – they do not face the same labour supply issues as developed markets, inflation is anchored, and rate-hiking cycles are almost complete. Once the Federal Reserve finishes the US rate hiking cycle, central banks in many EMs should be able to cut rates fast.
China’s policy is shifting gear but requires careful navigation
China’s regulatory environment has eased in terms of implementation, but broader social goals remain central to policymaking in the country. Policy considerations are key to effective stock selection.
At current valuations, fixed income investors are really being compensated for risk, while also gaining ongoing diversification benefits stemming from China’s economic divergence.
Backward-looking scores do not provide a robust analysis of sustainability risks and opportunities
An over reliance on backward-looking ESG scores is a flawed way to manage risks and capture opportunities. A forward-looking, qualitative approach is vital to gain a true picture of progress and potential, and a proprietary toolkit is essential, especially in EMs. A case in point is Brazil – third-party ESG scores are not reflecting the positive shift on environment policy under the new administration.
The global energy transition will be complex and non-linear and investment approaches should reflect this
Energy security concerns are acting as an accelerant for energy policy shifts and change is happening surprisingly fast; some industries have already reoriented away from Russian hydrocarbons.
Investors should be wary of jumping to simple conclusions on the investment implications of climate change and the global transition to net zero. A technological shift is taking place and it’s too early to say who will win. There will be divergent and idiosyncratic outcomes that countries and regions need to prepare for and hedge their bets around. China dominates in solar, wind and electric vehicles but is also building huge capacity in coal; expect a messy and long transition.
To profitably participate in the transition, focus on real-world decarbonisation and target EM investments
Decarbonising a portfolio will not generate a real-world impact for the energy transition. Rather than divesting from heavy emitters, investors can mitigate carbon emissions by supporting companies with credible transition plans while also providing capital for climate solution providers which offer the products and services that drive decarbonisation. EM corporates are at the heart of this.
This is not a free pass for investors to own high-emitting sectors. Instead, responsible investors must distinguish between companies that have practical and implementable transition plans and those that cannot or will not change sufficiently. Investors need the assurance that these ‘transition investments’ have the capacity to reduce emissions in the long run.
For transition investing to work, both carbon impact and commercial investment returns are essential.
