A new world order?

December, 2012 Print


Paul Cooper




As developed economies experience a slowdown in growth, paul cooper of sarasin discusses the regions which are most likely to fall under the emerging markets banner


There is no clear definition of what an emerging market is. According to Wikipedia the term “emerging market” was adopted to put a more positive spin on what had previously been called “less economically developed countries”. Although there is no consensus on the membership of the emerging world it is generally accepted that an emerging country will move from being “less developed” to “more developed” (though this is not always the case), and that it offers the potential for more attractive returns as a result, albeit with greater volatility and hence risk.

 Looking at emerging markets from an investment perspective is even more troublesome as index providers are sometimes inclined to classify countries on the basis of factors other than economics. For example, MSCI (the most widely followed index for emerging markets) continues to include South Korea and Taiwan in their global emerging market index, despite rising GDP per capita and a significant slowdown in growth over the past twenty years. Real GDP growth has averaged 3.6% in Korea and 3.8% in Taiwan during the last five years compared to 10% and 8.2% respectively for the equivalent five year period twenty years ago, while their GDP per capita discount to the United States has fallen by 43% and 40% respectively. These countries are presumably retained for continuity reasons rather than for economic reasons. Equally, an economy may satisfy the definition of “emerging” in all respects but fail to be included in the index on the basis of the liquidity or sophistication of its stock market. Countries in the Gulf, such as Qatar, Saudi Arabia and the United Arab Emirates, immediately spring to mind.

 This issue is important because indices are a key component of most investment processes. Risk is usually measured relative to benchmark and so the decision to invest in a country or even a company that is not in the benchmark will increase active money and absorb some of the risk budget. Given the size of the potential investor base, the inclusion or exclusion of a country or company could have a significant impact on the performance of the asset.

 Regardless of how you define it, there can be little doubt that emerging markets are a large and increasingly important geographic block. According to some forecasts, the world’s population is predicted to rise from 2.5 billion in 1950 to 9.1 billion in 2050, with the number of people living in India and Africa alone projected to increase by a staggering 3.4 billion. The emerging world (using the IMF definition) currently represents 49.8% of global GDP and according to PricewaterhouseCoopers the seven largest countries in the emerging world (China, India, Brazil, Russia, Mexico, Indonesia and Turkey) – the “E7” – will be 50% larger than the “G7” (US, Japan, Germany, UK, France, Italy and Canada) in 2050.

 China’s economy will of course slow over time; growth rates, savings rates and budget surpluses normally decline as national economies mature and China’s longstanding one child policy will have particularly serious consequences for its long-term workforce growth. Nevertheless, many other parts of the developing world will experience significant growth; PwC’s projected list of fastest growing economies to 2050 is headed by Vietnam, and the top 10 includes Nigeria, Philippines, Egypt and Bangladesh. India is expected to be the fastest growing major economy in the world from now to 2050.

 A growing population is one of the most important demographic trends behind the emerging market growth story. However, the ageing of the existing population in the emerging world receives much less attention and yet it is an equally important dynamic, as is the rising wealth and changing spending & saving patterns that accompany it. The question is can these trends be captured by investing in the emerging world? Although this may seem a strange question, the reality is quite revealing.



 Take healthcare as an example. If, like me, you think that the healthcare demands of the emerging world is an interesting long-term investment opportunity then you may be surprised to learn that healthcare represents just 1% of the MSCI Emerging Market Index. If you want exposure to emerging market healthcare you may have to look elsewhere for it.

 What about China; the gorilla of the emerging world? There is a great deal of interest in whether China will grow this year by 8% or 7% or whatever. I don’t know; what I do know is that Chinese growth over the next 50 years will look very different from Chinese growth over the past 50 years. In the US, consumption has averaged 70% of GDP over the last decade and its savings rate has been roughly 3.5%. In contrast, consumption has been 35% of China’s economy and its savings rate has been as high as 40%. The rebalancing of China’s economy towards consumption and services is a breathtaking opportunity and it will have profound implications for investing in China.

 As the Chinese increasingly move from the countryside to the cities their diets are changing; they are demanding more protein, they are eating more “junk food” and they are becoming fatter. Apart from the increasing demand for potash to fertilize and grow crops such as soya, which is good business for the Canadian company Potash Corp of Saskatchewan, there are other beneficiaries. Yum Brands is the largest restaurant company in the world, owning brands such as KFC, Pizza Hut and Taco Bell. Although it is listed in the United States its growth is being driven by its business in China. Yum Brands is therefore a beneficiary of the changing eating habits in China. Unfortunately, the consequences of eating more junk food can be seen in the growing prevalence of kidney problems and diabetes. Fresenius Medical Care, listed in Germany, is a leading healthcare provider and it is enjoying strong growth in the emerging world for its dialysis machines.

 So if as an investor you want to benefit from the consequences of dietary change in China there’s no point “buying China;” you should buy Potash Corp in Canada which helps satisfy their demand for protein, Yum Brands in America which provides the junk food they crave and Fresenius Medical Care in Germany which treats their resulting kidney problems.

 Sarasin & Partners has been an advocate of thematic investing since 1996. Our view is that the traditional approach, where portfolios are structured around indices is flawed because indices are by definition backward looking. We take the view that as most large companies operate on a global basis their fortunes will be determined by how they compare to their global peers, not the location of their headquarters or the stock market they chose for their primary listing. The thematic approach by contrast seeks to construct forward looking, high conviction portfolios without legacy or prejudice, structured around themes that cut across sectors, industries and geographical boundaries.

 Today’s emerging market fund manager should be encouraged to think more laterally about his or her brief. It could be that the most attractive companies are listed in the emerging markets themselves, in which case they should be bought, subject to valuation and corporate governance issues. It is possible though that the most effective way of gaining exposure to some of the strongest trends in the emerging world are in fact listings in the developed world; trends such as the rise of the emerging market middle classes, the need to increase resource efficiency or the inevitable rise in penetration of financial services – to mention just three. These are longterm, inexorable trends that will not be blown off course by a short-term cyclical slowdown in emerging market growth.

 The MSCI Emerging Market index is dominated by banks, telecoms and energy companies. It does not provide much exposure to healthcare or consumption or, outside the nonemerging economies of Korea and Taiwan, to technology. That doesn’t mean emerging market indices won’t go up in the long-term; they almost certainly will – perhaps sharply, but investors should be wise to what they are actually buying when they invest in a fund that tracks one of the well known emerging market indices.


 Compared to the developed world, which will experience little or no population growth and see its economic growth depressed by austerity measures for years, even decades, to come the relative growth dynamics of the emerging world have rarely been better. The reality though is that many beneficiaries will not be found in the emerging market indices. In order to truly profit from the remarkable opportunities that exist in the emerging world it is necessary to move away from the indices and buy the beneficiaries regardless of where they are quoted.

Emerging Markets FOCUS

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