Five lessons from a decade managing emerging market equities

A decade ago, there was one sector you really needed exposure to in your portfolio – global emerging markets. In 2016 the MSCI Emerging Markets index had a record year, rising 32.6%¹. But what disappointments were to follow.

It was April 2015 when we launched the Artemis SmartGARP Global Emerging Markets Equity Fund. Back then, emerging markets were seen as a riskier element of your portfolio but over the long term – because they were fast-growing economies with favourable demographics – they were expected to deliver much better returns. Following that record year in 2016, they kicked out another great set of numbers, rising more than 25% in 2017². And then things rather fizzled out.

Since 2015, the benchmark index has returned 63.0% and the typical fund 67.2%³ – an average annual return of just over 5%. My own fund has delivered 114%⁴ – close to 8% a year⁵. However, in the same period the S&P 500 has returned 185.7% – 13.3%⁶ a year.

Though emerging market performance in isolation has not been bad, we cannot ignore the relatively disappointing aggregate returns over the past decade.

Could the tide be about to reverse in favour of emerging market investing? Here are five learning points that might help anyone considering whether this sector deserves a fresh look (spoiler alert: I think it does) and how best to invest.

Be diversified

There are plenty of places to invest. Whilst India and China are dominant economies, other markets such as Latin America, eastern Europe, the Middle East and Africa have thrown up great opportunities for periods in the past decade.

Be picky

This is an asset class where good active management can deliver outsized returns over the long term. If I look at our portfolio today, the big fear is Donald Trump’s tariffs. We have 30% in China, but among these companies the proportion of revenue coming from the US is just 3%⁷. Our best-performing stocks last year (Geely, Alibaba, JD.com, Emaar Properties) outperformed all the Magnificent Seven.

Be realistic

Valuations matter. A decade ago, investors were cautious. Still smarting from the global financial crisis, they were buying so-called ‘safer’ stocks – consumer staples or healthcare companies. These became very expensive. The theory was that the consumer was becoming wealthier and consumption would therefore grow rapidly.

But paying 60x earnings for an Indian consumer staple is playing a dangerous game, and that was reflected in performance. Buying something at a good price is very protective in falling markets and can help you weather unexpected storms. Never lose the valuation discipline.

Be respectful

Too many investors have underestimated the capacity of emerging market nations. A decade ago, many deemed the best way to invest in emerging markets to be through developed market businesses selling to the growing middle classes in China and India.

Yes, that strategy worked for a long time, but many investors underestimated the potential for new brands to emerge from within these countries – not to mention new industries.

Look at the automotive arena. In the past four years, China has overtaken all other major car-producing countries. BYD sold more than 1.5 million cars in Q4 alone last year – up 61%⁸ on the previous year. And this growth has come despite the tariffs Trump enacted in his first term.

Companies like Icicle and Proya are disrupting the market for fashion and cosmetics, while manufacturers like Huawei, Vivo and Xiaomi are dominating the domestic market for smartphones and Sany Heavy Industry is helping to challenge digger company Caterpillar’s position in China.

So much for us expecting developed market brands to capture emerging market business. Instead, emerging market businesses are capturing developed market brands. The process was already under way 10 years ago. Today Chinese conglomerate Geely owns Volvo and more than half of Lotus. India’s Tata owns Jaguar and Land Rover. As for consumer staples, Weetabix is owned by Shanghai-based Bright Foods.

Be excited

Though many emerging market economies have matured considerably in the past decade, they still have a long runway for growth. They have some way to go in terms of development and infrastructure, in eliminating poverty and in enacting social reforms – all of which can help growth.

Relatively speaking, many emerging market countries still have positive demographic drivers – young working populations, urbanisation and improving education. In the past decade, the number of Chinese citizens enrolled in higher education has doubled to 60%⁹. China now boasts over 1,200 universities¹⁰, and India has a similar number¹¹. Meanwhile, in Brazil, São Paulo alone has 36 universities¹². China is already the second biggest global economy; India the fifth¹³. By 2030 China and India are forecast to overtake the US, and Indonesia will become the fourth biggest economy¹⁴.

What excites me most is the increase in the number and quality of companies I can choose from. Emerging market economies have come a long way in the past decade, and that means the narrative of high-risk high-growth has evolved. I believe the risks have fallen; maybe our expectations of growth have become more realistic.

The forces of globalisation are unwinding. Emerging market regions are become more self-sufficient. They are building stronger trading links between each other. Tariffs reinforce this shift and, ultimately, may end up hurting US companies most. And yet emerging market companies are so much cheaper.

In that light, an investor looking for a truly diversified portfolio and seeking genuine value cannot afford to ignore emerging market equities. The last decade was not bad. I believe the next could be better.