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Why emerging markets will ride a multi-decade tailwind


As the emerging markets grow more economically and financially liberal, managers are unlocking a “panoply” of opportunities outside the traditional darlings of the asset class.

“We all probably wanted to be the first investor into East Germany when it opened up,” says Marshall Stocker, co-director of emerging markets at Morgan Stanley Investment Management. “We’re trying to find countries that are going to be more market liberal and we’re not afraid to look at countries that are not market liberal. They offer opportunity for a direction of change; places like Serbia, or Uzbekistan, or Vietnam, where we think these liberalisations are happening.”

Even the world’s ostensibly Communist countries have introduced the pricing mechanism into some corners of their societies, Stocker notes, and the panoply of emerging markets will have a “wonderful multi-decade tailwind behind them” because they’re moving towards adopting the economic freedom of their advanced market peers.

“There’s a wonderful palette of colours in the emerging markets, and some of them are really exciting,” Stocker says. “Some of them are moving towards economic freedom, improving the rule of law, increasing the independence of the central banks.”

“The nice thing is that, collectively, we can find a rich set of these EM countries where excess returns come as the discount factor falls when these liberalisations happen. When we look at the aggregate level of emerging markets, the asset prices look reasonably attractive compared to developed markets.”

Still, Stocker is concerned about the trend towards deglobalisation, which has only been amplified by the pandemic and supply chain disruptions since the US-China Trade War began in 2018.

“The invasion of Ukraine by Russia showed us that national interests may occasionally trump economic rationality,” Stocker said. “There are national interests that are so valuable to some person or some group that they’re willing to sacrifice the marginal economic wellbeing of their constituents.”

“In the last several weeks there has been news that China has directed its state-owned enterprises to stop using Microsoft Windows within two years. That’s a pretty negative signal. That tells you there’s concern that globalisation is a national security threat.”

Stocker is one member of the horde of managers who have descended on Sydney and Melbourne in recent weeks to meet existing and prospective clients. Despite their recent woes, the appetite for emerging markets from local institutions is substantially higher than it was a few years ago.

“In this market where we saw emerging markets debt indexes fall across the board during the first quarter, investors took stock and are looking around to see what wasn’t a bubble – and I’d suggest that the global currency side did not enter a bubble – and they’re looking for asset classes that have underperformed relatively speaking,” Stocker says. “Institutional clients are very sophisticated – they chase weak performance rather than strong performance.”

“Looking forward to the remainder of 2022, we are optimistic on EM debt, as valuations appear to be well-compensating investors for the risk.”

The rapidly-industrialising economies of the emerging markets are often anathema to ESG goals, given the high number of pollutive industries they contain and labour practices generally considered to be behind those of developed markets. But Stocker believes that investing in markets with a clear pathway to liberalisation can have greater impact than a simple exclusionary approach. 

“When you invest in countries that are increasing economic freedom, ESG outcomes simultaneously improve,” Stocker says. “Finding these countries that are liberalising their economies, you wind up with stronger environmental, social and governance practices tackling issues such as child labour, cleaner air, higher literacy.”

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