In recent years, emerging markets have attracted significant
attention from investors due to their increasing share in global economic
output, stock market capitalization, favorable demographics and high economic
growth expectations. Emerging markets are the developing economies with
rapid growth and industrialization. These countries possess securities markets
that are progressing toward, but have not yet reached, the standards of
developed nations. Emerging markets typically have fewer and smaller publicly
traded companies than developed markets. However, the securities markets in the
developing world are also characterized by lower liquidity, less regulation,
and weaker accounting standards than more mature markets such as the U.S., Japan,
and many countries in Europe.
Why consider Emerging Markets for Investment
Emerging markets attract investors for various reasons
including fast rapid economic growth, favorable demographics, growing
consumption potential and offers a healthy investment diversification. Although
emerging markets have been relatively more volatile than developed nations,
particularly US, exposure to these markets can actually decrease overall
volatility when returns of individual holdings diverge. Emerging markets have a
potential to emerge as a solid investment avenues with an above-average returns
on investments driven by comparatively better earnings growth.
Historical performance of Emerging Markets
Emerging markets have disappointed investors in
recent years mainly on account of weaker commodity prices, sluggish exports and
political instability amongst others. The corruption scandal in Brazil, China’s
slowing economic expansion (GDP slipped from 7.3% in 2014 to 6.9% in 2015) and the
oil-induced recession in Russia added to the woes of investors. Over the last
five years, the MSCI Emerging Markets index, which tracks the stock markets of
developing nations, has provided negative annualized returns of -4.7% as
against a 12.3% annualized returns for S&P500. However, the long term
returns since 2003 tell an altogether different story as the MSCI Emerging
Market index has outperformed S&P500 index by ~200 basis points to fetch
annualized returns of 11.0% by the end of 2015.
In 2016, the
continued downtrend of emerging markets performance since 2011 has reversed as
the emerging market equities have rallied 15.5% YTD this year, outperforming
the S&P500 by 7.4%. The world’s foremost emerging markets – Brazil, Russia,
India and China (BRICS) have recorded positive returns till date with the two
cheapest and most hated Emerging Markets, Brazil and Russia topping the list. With
63.1% YTD returns, Brazil appears to be a clear winner among the emerging markets
signaling the easing of political instability in the country. India, with
better investment sentiments, generated 7.8% returns followed by 6.9% returns
by China. Investors believe this positive reversal will continue for the next
few years backed by the stabilizing commodity prices, recent developments in
India and China along with easing political instability in Brazil, offering a potential
buying opportunity.
The weaker dollar helps the movement of emerging
markets as the performance of emerging markets is inversely proportional to the
dollar index. Historically, many factors including strong geopolitical forces
and higher interest rates in the US have led to the relatively stronger dollar
as compared to other currencies, especially emerging market currencies. The US
dollar index closed at $96.02 as on Aug 31, 2016, down 2.6% YTD. The Federal
Reserve recently kept its benchmark rates unchanged in response to sluggish job
creation in preceding months and discouraging economic data resulting in the
weakening of dollar index. Amongst the emerging market currencies, Brazilian
Real has appreciated 18.3% YTD, followed by Russian Ruble (10.5%) and South
African Rand (5.0%) while Chinese Renminbi and Indian Rupee have depreciated by
2.8% and 1.2% respectively.
Going forward, the emerging markets tend to benefit
provided the world’s major central banks continue to maintain their dovish
stances on key benchmark rates. The markets seems of the view that the US
Federal Reserve will keep rates low in the short term and may not ever raise
them back to historical norms thereby helping the asset classes that benefit
from low interest rates. An environment of negative yields also forces
investors to rebalance their investments in asset classes from fixed income
securities to equities in search of higher yields. Therefore, we expect
emerging markets to continue to see growing interest, as US fixed-income
investors seek higher yields overseas and equity investors expect capital to
continue flowing into emerging economies.
India
appears to be well positioned to benefit from the capital flows to emerging
markets
India is one of the fastest growing
economies in the world with expected GDP growth of 7.6% for FY2016-17 as
against the 2.6% growth of world economy as cited by World Bank. The country is
well positioned to achieve the targeted growth on account of improved
governance and streamlined tax regimes, good monsoon, an acceptable range of
fiscal deficit and improved investor sentiments after introduction of BJP
Government led by Prime Minister Mr. Narendra Modi.
Among major emerging market economies, India's
growth is the highest and the Indian rupee has been a relatively better
performing EM currency in the last few years. India has recently outpaced China
as the world’s fastest growing economy and is expected to maintain the lead for
the next few years as India’s emerging market counterparts are projected to
grow at relatively slower pace. After recording 6.9% growth rate last year, the
lowest in last two and half decades, China is expected to grow relatively sluggishly
at 6.7% in 2016. Brazil and Russia are expected to continue facing deeper
recessions given the plunge in commodity prices and weak oil revenues while
South Africa is expected to grow at 0.6%.
India seems to relatively insulated from the
aftershocks of Brexit as it has lower export dependency on Britain as well as
fiscal and monetary flexibility following improving fiscal deficit situation
and rising foreign exchange reserves. This positive optimism is evident from
the 17% CAGR in the cumulative investment inflows (both debt & Equity) in
India in last decade. The FPI investments till Aug 2016 this year were recorded
at INR335.01 billion.
The quality of governance is also improving
quite dramatically after the Narendra Modi led BJP Govt came into power with
majority in 2014-15. It can be evidenced by introduction of measures like the
Bankruptcy Law and the Land Acquisition Bill, easing the norms for FDI, cleaning
up the Indian banks' balance sheet, commitment to recapitalization, and streamlined
tax regime with the introduction of uniform Goods and Service Tax (GST). The
Government is committed to improve business environment in India by
implementing a stable, predictable and congenial tax regime. This would help
improve India’s current 130th ranking in ease of doing business.
Demographically, India has the youngest
population in the world with median age of 27 yrs, compared to 37 in China, 38
in US, 41 in Europe and 46 in Japan. More than one third of India’s current
population (1.3+ bn) is aged between 15 and 34 years, out of which half of the
population is aged at 24 yrs. Over the next five years, India’s population is
expected to grow by 1.4%, as against 0.5% growth in China, 0.9% growth in US
and 0.3% growth in Europe.
