Many investors operate under the assumption
that emerging markets (EM) equities can generate superior returns simply
because EM countries generate higher rates of economic growth than the developed
world does. In our view, not only is it incorrect to assume that all emerging
markets are growing at a faster rate, but it is also wrong to use macro growth
as the basis for investing in EM equities and pursuing sustainable returns. To
generate long-term alpha in emerging markets equities, investors need to apply
the same approach that should be applied to investing anywhere — invest for the
long term in attractive companies with durable growth, sustainable advantages,
and real options that will manifest over years. These opportunities exist not
only in economies posting strong gross domestic product (GDP) growth, but also
in low-growth economies where companies are able to tap into structural demand,
and deliver innovative products and services or to monetize their unique
EM growth story has not lived up to the hype
The data show that, with a handful of rare
exceptions, macro growth across the EM landscape has hardly been outstanding. Among
the 20 largest EM economies, 15 have posted less than 5% compound GDP growth
over the past 10 years — and this is nominal, not real growth!1 Beyond
China, only India, Indonesia, the Philippines and Pakistan have posted high single-digit
compound GDP growth over the past decade. It is worth noting that some of the
largest economies in the EM world have hardly been able to sustain nominal
growth, in US dollar terms, in excess of 1% compound over the past 10 years. These
include Mexico, Brazil, Russia, Turkey and Poland. And frankly, the past five
years have been even more brutal since the EM currency and commodity collapses
and with the recessions across much of the EM world, particularly in Latin
America (Brazil, Argentina, Mexico) and the EMEA (Europe, Middle East, Africa)
markets (specifically Russia and Turkey).2
1: Nominal Gross Domestic Product (GDP) growth across emerging markets
Figure 1 also highlights another very
important fact, which is that growth both across the EM landscape and the rest
of the world has deteriorated significantly over the past decade. The superior
EM growth story is really a residual of the first decade of the 21st
century as evidenced by the fact that the 18-year compound annual growth rate
(CAGR) for manyEM countries is considerably higher than the CAGR for the past
In our view, the growth of 2000 to 2010 is
anomalous, and unlikely to return anytime soon. It was a function of the
convergence of several favorable trends: the rise of China, the boom in
commodity demand and prices, and the “darling years” of globalization. In
addition, the developing world benefited from the significant reforms forced
upon EM governments to address the pressures associated with the Asia Financial
Crisis (1997-1999) and its deleterious impact on commodity exporters. Thus,
growth during the 2000-2010 period was amplified by a re-leveraging of most of
the developing world.
Starting in the early 2000s, after decades of
economic crises, the emerging world started to close the income gap with
advanced economies and experienced growth consistently above that of the
developed world. For many investors, the emerging world seemed to be on the
promising path of convergence with developed economies, and that appeared to bode
well for their ability to deliver more attractive returns relative to their
developed peers. 3
EM growth challenge explained
We feel the real culprits for the EM stagnation problem are inequality and the lack of social mobility. We have written previously about the economic conditions in India, South Africa and Mexico. We view inequality is a major hindrance for growth in the developing world and, increasingly, in the developed world, as well. The dual-track economies prevalent in many large EM countries are characterized by a small and reasonably efficient formal sector dominated by a handful of companies that have access only to vast pools of informal (and inefficient) labor. The absence of social mobility impairs these countries’ capacity to bring much of the population into higher productive sectors and ultimately reduces their national savings and capital formation, which are critical drivers of development. In equality, perhaps the most significant economic challenge of our age, is pronounced in much of the developing world. These circumstances are particularly extreme in South Africa, Colombia, Chile, Brazil and Mexico, as revealed by the Gini Index, which is a measure of a country’s income dispersion. (Figure 2). However, it is worth noting that many of the larger economies in the EM world have reasonably small upper/middle income populations within large overall populations that rival the population size of some continents. That means the underlying inequality is significantly higher than what the Gini-coefficient measures. Countries that fit this profile include India and Indonesia.
2: Gini Index
Insufficient state resources are another key
culprit contributing to the development challenge in many emerging economies.
Simply put, many EM governments have insufficient fiscal resources to improve
social mobility through the necessary investments in physical and social
infrastructure. Brazil is perhaps the most notable exception to this. While Brazil
is a big state in terms of resources, it unfortunately suffers from
dysfunctional democratic institutions. The consequences of that have been limited
discretionary spending, high debt, and a massively inefficient administration.
3: Ration of fiscal expenditure to GDP
An aside we never get tired of pointing out…
We want to make an important aside in this discussion, which is that four of the largest EM economies are inappropriately labeled EM economies. These four are evenly divided between highly industrialized, productive but small, open economies (South Korea, Taiwan), and rich Gulf states with small populations and abundant hydrocarbon resources (Saudi Arabia, United Arab Emirates). As an additional aside, we have consistently run a dramatic underweight in these countries largely because the opportunities to unearth outstanding companies there are limited. These four rich “EM” countries represent a quarter of the MSCI EM benchmark, but only 7.17% of the Invesco Oppenheimer Developing Market Fund, as of August 2, 2019.4
Figure 4: GDP per capita—Purchasing Price Parity (PPP)
The exception that is China
China, of course, is the true growth engine of
EM — one that has been running now for nearly four decades! Despite significant
headwinds from a deterioration in external demand, China has been able to
deliver 11% CAGR nominal GDP over the past 10 years and 14% CAGR from 2000-2018.
China has accounted for 45% of the increase in EM GDP (among the 20 largest
economies) since the beginning of the century and has added $12 trillion of GDP
during the past 18 years. This contrasts with $2.2 trillion of GDP in India,
$1.4 trillion in Russia and $1.2 trillion in Brazil, three of the other large
EM economies. China’s contribution to global growth is also larger than the $10
trillion of GDP growth that the United States has posted this century, despite
the fact that the US is a significantly larger economy. All of this has
resulted in China becoming an economy nearly as large as the next 19 largest EM
economies combined. China accounted for 45% of total GDP generated in these
countries in 2018.
Where to go from here
To sum up, the case for investing in EM
economies, more broadly, is NOT about superior economic prospects, or these
economies’ convergence with the developed markets of Europe, Northeast Asia,
and the United States. In a world of deglobalization, improved growth prospects
in wide swaths of the developing world will depend on structural reforms.
Fiscal reform, administrative efforts to improve social mobility and financial
inclusion, and state capacity to invest in physical and social infrastructure
are really the political imperatives to structurally improve growth. As we
noted in part I of this series (False
Narratives: Rise of the Emerging Market Middle Class),
we see glimmers of optimism throughout the developing world with the political
rise of “the progressives” across the EM landscape, including Indonesia,
Mexico, India and pockets of sub-Saharan Africa. Time will tell how this story
Nevertheless, the real case for investing in
EM equities over the long term remains unfazed: one can capture the opportunity
of EM by looking to uncover extraordinary businesses that have the capacity to
generate above average earnings growth, even in pedestrian macro environments.
This has been the hallmark of our approach to investing in the developing world
In slower growth economies — in both developed
and emerging markets — there are two broad categories of companies that meet
these criteria: globally competitive companies that are not entirely dependent
on their domestic markets and domestic disrupters that gather market share in
their own markets over time because of their significant efficiency advantages.
In the Invesco Oppenheimer Developing Markets Fund,
some of our largest, longstanding investments are in globally advantaged
companies such as Novatek, the Russian gas “behemoth” behind the unfolding Liquefied
Natural Gas revolution in the Yamal Peninsula; Taiwan Semiconductor, the
dominant global semiconductor foundry; and Tata Consulting, one of the world’s
leading Information Technology services giant. Much of the balance of the
Developing Markets Fund is concentrated in domestic disrupters, companies that are
growing by increasing efficiencies in relatively pedestrian growth economies.
These include our large holdings in Latin American retail (FEMSA, Falabella,
Lojas Americanas) and our selective investments in EM banks (Credicorp, Kotak,
of the latest quarter end (June 30, 2019), Novatek represented 4.60% of Invesco
Oppenheimer Developing Markets Fund’s holdings; Taiwan Semiconductor, 3.62%;
Tata Consulting, 1.28%; FEMSA, 1.93%; Falabella, 1.15%; Lojas Americanas,
1.10%; Credicorp, 1.95%; Kotak, 3.17%; FirstRand, 1.90%; and Akbank, 0.66%.
1 Source: Unlike real gross domestic product, nominal gross domestic product reflects price changes from inflation.
2 Source: EM Advisors as of Dec. 31, 2018
3 Source: The World Bank as of Dec 31,2017,
the most recent data available
4 Source: Weights of the Fund in South
Korea, Taiwan, Saudi Arabia and the United Arab Emirates is 7.17%, as of June
30, 2019. (The Fund does not have allocation to Saudi Arabia.) Weights of the
MSCI Emerging Markets Index across South Korea, Taiwan, Saudi Arabia and the
United Arab Emirates is 25.29% as of June 30, 2019.
Blog header image: Nikada / Getty Images
expressed are those of the authors,
are based on current market conditions and are subject to change without
notice. These opinions may differ from those of other Invesco investment
Holdings are subject to change
and are not buy/sell recommendations.
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securities of foreign issuers, including emerging market issuers, can include
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