Mike Taylor: Emerging markets have time on their side

The growth of Chinese e-commerce company Alibaba (pictured) shows why tech-savvy emerging markets are such a force. Photo / Getty Images

COMMENT: "Get in early" is a good general principle for investment.

Time is your friend when you're investing for retirement or a goal equally far off.

For individual investments, getting in early can get you something cheap and you can benefit when the market catches on.

But the best version of starting early is with something with a large, enduring, concrete impact on your nest egg. Something encompassing multiple investments, like getting in early with new industries or themes.

Emerging markets (EM) are perhaps the best example of this. They cover entire industries, sectors and countries.

Investors who like EM like them a lot. Investors who don't, have either just not thought about them — which is why they still qualify as an "early" opportunity — or they've been burned, and are not keen to repeat the experience.

What are emerging markets?

For an investor, the meaningful aspect of "emerging" is that the market is growing. Its people are earning more, expecting more, spending more. Standards of living are improving, markets are becoming more open.

The term EM, and the perspective, are very Western-centric. China, India and Brazil are classed as EM while being huge economies.

This perspective matters, however, because EM companies want offshore investors. It gives them a new pool of investors, enhances their reputation at home and abroad, and can give them new ideas about how to operate.

Why invest in them?

Because of the people. "Emerging" countries such as India, Indonesia and the Philippines are where a lot of people are. Most important, because of population growth, they're where the most people will be in future, relative to ageing, developed countries.

Recent work by Standard Chartered Bank to forecast each country's share of global gross domestic product (GDP) — the measure of every country's total economic activity — has China ahead of the United States by next year (2020). That shift is expected to be permanent.

The forecast also puts India ahead of the US by 2030, when EM countries will be seven of the top 10 overall.

The potential for growth in population, wealth, living standards and demand for goods and services is massive.

A Credit Suisse survey of consumers in emerging markets countries showed that between 2013 and 2017, 45 million households moved into the US$1000-US$2000 monthly household income bracket. The size of the movement, not the income amount, is the important part.

And there's plenty of momentum behind it. In 2016, China and India had more than 7 million Stem (science, technology, engineering and mathematics) graduates between them, while the US and Japan had only 760,000.

The growth of Tencent, Alibaba and Baidu are good examples why tech-savvy young EM people are such a force. They're assisted by the availability of smartphones — many EM consumers have bypassed bricks-and-mortar retail altogether, rather than shopping shifting online as it has in older, developed markets.

What to think about

Even if the scale of the EM opportunity is vast, investors should be cautious. They're "emerging" for a reason.

Political scientist Ian Bremmer defined an emerging market as a "country where politics matter at least as much as economics to markets".

The country may not yet be a democracy and the rules and regulations governing local companies, and the ability of offshore investors or companies to participate in its markets, can change quickly.

Corporate governance standards may be different (although developed markets have their share of governance shocks).

All this can make EM investing more volatile, even with tailwinds. Include language differences, and New Zealand investors must do solid research and be selective and patient.

They can remove risk by investing in a range of EM companies through a relatively low-cost exchange-traded fund, or through a manager who knows what they're doing.

Why now?

If EM is such a good long-term opportunity, surely any time is a good time to invest? Yes, but like any market, some times are better than others. Now seems better than most.

EM typically does well when the US and other developed countries have done poorly, because their economies are influenced by different things.

Until recently, booming US markets and an equally buoyant US dollar have seen most EM stock indexes plunge. Trade tariffs and the associated noise have not helped.

In the turbulent conditions of 2018, MSCI Emerging Markets fell 14.6 per cent compared to MSCI World falling 8.7 per cent. Emerging markets currencies, such as the Turkish lira, Mexican peso and Brazilian real, have been pounded, increasing the hurt.

It has been a rough ride for EM investors. But the result, relative to history, is that EM equities are very cheap.

Carlos Hardenberg, co-founder of EM investing specialist Mobius Capital Partners, recently wrote that investors will look back to right now as "a very unique time to get exposure to these vibrant economies and underlying companies at multi-year low valuations".

The book values of EM companies are at 12-year lows — even lower than just after the global financial crisis — most of which, according to Hardenberg, is pessimism.

But it's not just that what falls must rise. Hardenberg and others say EM economies are now better prepared financially — for example, by having less debt — to weather market volatility than the past.

While 2018 overall was bad for EM, most of the pain came before the final three months when the US had its worst market ructions since the global financial crisis (and the worst December, for the S&P500 index, since the Depression).

In that last three months, MSCI EM was down 7.5 per cent compared to MSCI World losing 13.4 per cent and in December EM was down only 2.65 per cent to MSCI World's 7.6 per cent.

Even political risk may not be as concentrated in emerging markets as it was.

Increasingly, political volatility is coming from US leadership and upheavals such as Brexit in the UK.

So if you are looking to diversify, it's worth considering emerging markets.

- Mike Taylor is founder and CEO of Pie Funds.