How emerging markets are evolving

A growing business should never stand still.

It must be willing to innovate and evolve, in order to keep pace with an ever-changing world. And while successful businesses change with the times, so do the markets where they’re based.

This article isn’t personal advice. If you’re not sure if an investment is right for you, please seek advice.

A closer look at emerging markets

The stock markets of emerging economies have evolved significantly over the years. Only a decade ago, the main emerging markets index was made up of 740 companies, but the number has since almost doubled.

Back then, the market was mainly home to companies that are more prevalent in the earlier stages of a country’s development, like natural resources and financials stocks. Brazilian commodity companies Petrobras and Vale were two of the largest companies in the emerging markets. So was Russia’s Gazprom, and a number of Chinese banks.

Banks often form the core of an economy. They provide capital and loans to businesses to thrive, and offer a place for people to get paid their wages and make basic transactions. Other commodity-related businesses are also generally needed for economies to develop. These provide the resources or infrastructure to build the essentials for a growing economy, including roads, railways, property and telecoms networks.

What binds these businesses together is their need for large capital investment or physical assets to keep growing. But as economies mature, or technologies develop, they make up a less important part of an economy or stock market.

Asian and emerging markets have gradually moved away from some of these so-called “old economy” companies to the “new economy”. The rise of the middle class and changes in consumer behaviour have helped to drive this change. And in recent months, the coronavirus pandemic has helped accelerate these trends.

Adapters of technology

An increasing number of businesses can now make profits without needing as much ongoing capital investment. For example, ecommerce businesses that operate mainly online, or consumer staples firms with well-known brands that have loyal customers.

It means internet companies now dominate the top of the Asian and emerging markets, with the likes of China’s Alibaba, Tencent and JD.com, South Korea’s Samsung Electronics, and Taiwan Semiconductor Manufacturing. They’ve performed particularly well in recent years, and again during the recent virus-related volatility, meaning tech and communication services now make up almost one third of the index.

Charts showing top 10 sectors in 2010 v 2020, clockwise by size

Source: JP Morgan, 30 June 2020.

That isn’t to say “old economy” stocks will languish forever. Financials, like banks and insurers, will always have a place in most markets. Resource and materials businesses are also likely to be needed. But there’s often less certainty around their earnings, as their success is tied to commodity prices and demand from companies and economies. Their performance usually depends on where we are in the market cycle, or the health of different economies.

Strong companies, strong countries?

The geographical mix of emerging markets has also changed. Again, looking at the market a decade ago, countries like Brazil, Mexico and South Africa had a much bigger presence. So there was a greater spread across the broader regions of Latin America, Asia, Africa and Eastern Europe.

But Asia in particular has become a force to be reckoned with over the years. Asian economies once accounted for around 60% of the broader emerging stock market, but now make up almost 80%.

Chart showing top 10 countries in 2010 v 2020, clockwise by size

Source: JP Morgan, 30 June 2020.

China’s growth is the main reason for this. It’s gone from forming 19% of the market to just over 40% and is now the second largest economy in the world, behind only the US.

Its ballooning tech sector has played a key role in this, and so has the inclusion of some of China’s A-shares into major indices. These represent thousands of domestic Chinese companies, and more are expected to be added over the years. There’s room for China to become an even bigger part of the market.

Some commentators say emerging countries like China, South Korea and Taiwan will soon develop enough to be removed from the emerging markets index. That said, while they’re transitioning to more modern, industrial economies with higher standards of living, they typically need to operate as full democracies to achieve developed status. That’s unlikely to happen any time soon, but it’s not out of the realms of possibility in the future.

What does this mean for investors?

We think Asian and emerging economies offer significant long-term growth potential. They’re home to hundreds of companies that don’t just stand still – they’re prepared to work hard, continue to evolve, and are ready to compete with their western counterparts. Growing wealth, changing consumer habits, and quick adoption of technology offers vast investment opportunities.

If anything, looking at the way the market has evolved is a good reminder to check your investment portfolio offers the diversification you expect. Or how different it might look over time.

In particular, keep an eye on index tracker funds. They aim to closely match the underlying investments and performance of an index. So they’ll look different over time depending on how the index changes, and be biased towards different sectors and countries.

We think tracker funds are a great way to get diverse and low-cost weighting to a particular area. But it’s still important to consider how the underlying investments change over time, and check this fits with the rest of your portfolio and long-term investment objectives.

Active funds are another way to invest. They’re run by a professional investment manager who decides which companies, countries and sectors to invest in, depending on where they find the best opportunities. This can increase risk though – there’s potential for the fund to perform better than the index over the long run, but the reverse is also true.

Remember all investments and any income from them can fall as well as rise in value so you could get back less than you invest.

The Asia and emerging markets funds on the Wealth Shortlist each offer something different from one another, so there’s the opportunity for plenty of diversification within the sector.

Some of the funds invest a little in frontier markets like Vietnam, Argentina, Kuwait or Nigeria. They’re usually smaller countries at an even earlier stage of economic and political development.

Investing in frontier markets is considered higher risk than emerging markets, and emerging markets carry more risk than developed markets.

It’s still important to consider how the underlying investments change over time, and check this fits with the rest of your portfolio and long-term investment objectives.

Looking for ideas?

Investing in these funds isn’t right for everyone. You should only invest if the fund’s objectives are aligned with your own, and there’s a specific need for the type of investment being made.

Make sure you understand the specific risks of a fund, and that any new investment forms part of a diversified portfolio.

We’ve given some ideas for your interest, but they aren’t a guide to how you should invest. Ask us for advice if you’re not sure an investment is right for you. Remember emerging markets are higher risk.

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ASI Asia Pacific Equity

Gives exposure to the Asia Pacific region, including both established and less-developed economies like China, India and Taiwan. The fund focuses on larger companies and usually has at least some weighting to most major sectors.

More on ASI Asia Pacific Equity, including charges

ASI Asia Pacific Equity Key Investor Information

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First Sentier Asia Focus

A range of Asian economies including Singapore, Hong Kong, India and Taiwan are included in this fund. The fund’s focused on larger companies in consumer-related areas, as well as some medium-sized companies with strong growth potential.

More on First Sentier Asia Focus, including charges

First Sentier Asia Focus Key Investor Information

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iShares Emerging Markets Equity Index

This fund aims to track the performance of the broader emerging stock market, as measured by the FTSE All-World Emerging Index. It invests in a spread of almost 1,500 companies, including higher-risk smaller companies, across a range of sectors.

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iShares Emerging Markets Equity Index Key Investor Information

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iShares Pacific ex Japan Equity Index

This fund aims to track the performance of the broader Asian stock market, as measured by the FTSE World Asia Pacific ex Japan Index. It’s diversified across different sectors and invests in around 600 companies.

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iShares Pacific ex Japan Equity Index Key Investor Information

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Jupiter Asian Income

This fund focuses on providing an income, along with some growth, so it invests in dividend-paying companies. Charges are taken from capital which can increase the yield, but reduce the potential for capital growth. The manager mainly focuses on larger businesses in developed Asian markets, like Hong Kong, Singapore and Australia. The fund invests in a smaller number of companies, meaning each can have a big impact on performance, increasing risk.

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Jupiter Asian Income Key Investor Information

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JPM Emerging Markets

This fund invests across the emerging markets, including China, Brazil and South Africa. The managers mainly invest in large firms, but also some medium-sized companies with greater growth prospects. They currently mainly focus on three core areas: the technology, financials and consumer sectors.

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JPM Emerging Markets Key Investor Information

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Schroder Asian Alpha Plus

This fund mainly invests in larger companies across Asia, based in countries like China and South Korea. It’s currently focused on sectors that can be more sensitive to the health of the economy such as technology, financials and consumer services. It can use derivatives and invest in smaller companies which can increase risk.

More on Schroder Asian Alpha Plus, including charges

Schroder Asian Alpha Plus Key Investor Information

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Schroder Small Cap Discovery

This fund invests in higher-risk smaller businesses that are based in Asian and emerging markets, or make most of their money in these areas. It’s currently invested in companies that could benefit from growing domestic consumption.

More on Schroder Small Cap Discovery, including charges

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