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EM investors to reap rewards of a ‘decade of transformation’

China’s reduced dominance in the emerging markets has changed the composition of the index, providing greater choice and diversity for investors as supply chains relocate and Asia becomes the world’s AI factory.
Analysis

By the end of 2020, China’s share of the MSCI EM equity index rose to nearly 40 per cent, propelled by the decision to include American Depositary Receipts (a bank-issued certificate representing shares in a foreign company for trade on American stock exchanges) and award China A-shares a larger index allocation.

But the abrupt shift in China’s regulatory priorities, tightening macroeconomic policy and the negative impact of geopolitical tensions has seen that share fall to 26 per cent – a “major transformation” that has created a more diverse and higher-quality asset class. 

“While selectivity will always be key in this richly diverse opportunity set, the market provides exposure to compelling growth stories and plenty of companies – including those in the technology sector – that are at the forefront of global developments,” Ninety One portfolio managers Archie Hart and Varun Laijawalla and portfolio specialist Jen Ford wrote in a note titled “EM equities: a decade of transformation”.

  • “Corporate governance and standards of operating performance have improved substantially, as has the governance of the economies in which they operate, resulting in robust structural foundations for continued growth and a compelling investment case for EM equities.”

    As China’s dominance in the index has receded, India’s share has surged accordingly – it now accounts for a fifth, with Covid accelerating trends that have been particularly to its corporate sector – but Ninety One reckons that alpha opportunities still abound for those investors able to conduct extensive on the ground research. Vietnam, Thailand and Malaysia are all reaping the benefits of supply chains relocating out of China, while Mexico is also enjoying the tailwinds of a more multi-polar world.

    But there have been significant positive developments in China as well. The nature of its index participants has changed, with state-owned enterprises (SOEs) lagging the “increasingly globally competitive” cohort of private institutions.

    “The market value of the top 20 companies in the MSCI Emerging Markets index, only 7 per cent is now in SOEs/resources businesses, down from 54 per cent in 2010,” the note says. “At the same time, of the privately run businesses, currently one-third are Chinese companies, compared to 2010 when the only Chinese companies that featured in the top 20 were SOEs.

    “Chinese listed companies are also becoming more shareholder friendly and ultimately more investable as a result. We are encouraged by the improved corporate governance in recent years, in both levels of share buybacks and dividend payouts.”

    The weight of technology in the index has also increased over the last decade, with the tech sector now representing around a third of the EM equity market – shifting the quality of the asset class as “new-economy companies innovate, disrupt and grow”, crowding out companies that are more capital intensive and less focussed on profitability.

    “That translates to an abundance of interesting investment opportunities in technology businesses that are innovating, forward thinking and resilient,” the Ninety One report says. “A recent catalyst here is the growing emergence of AI.

    “While American companies own the intellectual property, the infrastructure which it will run on (data networks, data centres, computers and smartphones) will be largely manufactured in Asia. We are seeing Asia emerge as the world’s AI factory, driving a widening range of technology sub-sectors.”

    Lachlan Maddock

    Lachlan is editor of Investor Strategy News and has extensive experience covering institutional investment.




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