Different ways to invest in emerging markets

Emerging markets have long divided opinion. Those in favour cite the chance of better-than expected returns; those against warn of increased volatility.

Both views are valid. These areas have huge potential because they are still developing, but no one can promise the investment journey will be smooth. Therefore, the amounts you should commit to these areas will depend on your longer-term goals and attitude to risk.

Here, we take a look at emerging market bonds and equities and highlight funds that are worth considering.

What is an emerging area?

While there’s no accepted definition of what constitutes an emerging market, according to the International Monetary Fund (IMF), they are generally described as developing economies that are undergoing rapid industrialisation, urbanisation, and economic growth.

They tend to be characterised by traits such as favourable demographic trends, expanding middle classes, increasing consumer spending, and a growing appetite for foreign investment.

Why invest in emerging areas?

The key benefit of emerging markets is getting exposure to tailwinds that have the potential to boost longer-term returns. These include demographic advantages over the West, manufacturing capabilities, resource advantages, digitisation, and a focus on developing infrastructure, according to Federated Hermes. “Emerging markets account for 82% of the world’s population but currently only 26% of global market capitalisation,” it stated.

While emerging markets often offer significant investment opportunities due to their potential for high returns, they also come with higher risks, such as political instability, regulatory uncertainties, and volatile market conditions.

However, it’s important to acknowledge emerging areas aren’t all the same. “These economies are dissimilar, and the distinction between emerging markets and other developing economies is also imprecise,” the IMF added.

How to invest in emerging markets

You can invest in both emerging market bonds and equities. Each asset class will have its various pros, cons, and drivers.

Let’s start with portfolios focused on emerging market debt.

M&G Emerging Markets Bond, which is managed by the knowledgeable and experienced Claudia Calich, is one of our favourites in this space. It has the flexibility to invest across the whole emerging bond spectrum, including government and corporate bonds denominated in local currencies or the US dollar.

Claudia and her deputy manager, Charles De Quinsonas, begin by looking at macroeconomic factors such as politics, central bank policies, inflation, and commodity prices. They will then look at individual countries – and will then consider the government and corporate bonds on offer in those they favour.

According to her most recent commentary, April 2023 was a generally calmer period for bond markets. “Although emerging market debt experienced heightened volatility, mainly due to inflation data in the US and the UK and corporate earnings reports,” she said.

This resulted in progress. “All major segments of the asset class registered gains,” she said.

As well as focusing on new issues from Eastern Europe, Claudia also participated in a sustainable 10-year euro-denominated sovereign bond from Cyprus. “In corporate bonds, we added national rail company Georgian Railway and state-owned Colombian oil and gas company Ecopetrol,” she added.

Richard Hodges, manager of Nomura Global Dynamic Bond, also likes selected bonds in emerging markets. “Lower peak interest rates [in the US] gives us greater conviction in our emerging market positions, and we have added to exposures in both Latin America and Eastern Europe recently,” he said.

Invesco Tactical Bond manager, Stuart Edwards, has also ventured more into the asset class. In a recent ‘Investing on the go’ podcast* he told us that emerging markets are a really broad church: “You have hard currency emerging market bonds – and by that we’re talking about typically US dollar denominated bonds – and you also have local currency bonds as well – that’s bonds issued by the larger emerging markets in their own local currencies, where the sensitivity to their own interest rate cycles is a lot greater,” he said.

“We’ve increased our exposure in some very selective opportunities because some of these [emerging market] central banks have been even more aggressive than the Bank of England or than the US Federal Reserve. Think Mexico, think Brazil – these are two countries that raised rates quite aggressively and, as a consequence, we’ve found some quite attractive valuations in these markets.”

Investing in emerging market equities

Then there are portfolios focused on emerging market equities. One of the funds we prefer is the GQG Partners Emerging Markets Equity fund. GQG Partners is a relatively new name in the world of asset management, having only launched seven years ago, but has plenty of experience in its team.

Rajiv Jain, the company’s founder and lead manager for the emerging markets equity portfolio, has been in the industry for more than a quarter of a century. His Emerging Markets Equity fund invests in high quality, attractively priced companies that demonstrate competitive advantages over their rivals. Currently, the 10 largest holdings in the fund account for 38.8% of assets under management, with the largest being the 7% in Petrobras, the Brazilian petroleum giant**.

Another option we like for equity investors is the JPMorgan Emerging Markets Trust that’s run by the respected Austin Forey. He’s succeeded in delivering excellent returns for the past two decades, proving that his long-term approach to stock picking clearly works. The aim of the fund is to maximise total returns from emerging markets, with the focus being on companies, rather than countries.

Looking ahead, Austin remains broadly optimistic for the asset class, especially as emerging market earnings expectations were downgraded throughout much of 2022. “Given China’s reopening and low starting point, if global demand does not roll over, we believe there is room for emerging market earnings to surprise to the upside as the year progresses,” he said.

The strength of the US dollar will also be key. “The US dollar was extremely expensive in the second half of 2022,” said Austin. “However, in the last eight months, the US dollar weakened meaningfully for the first time in several years. Typically, emerging market equities’ outperformance is positively correlated to a weaker US dollar, so the dollar’s trajectory from here will be key for the asset class.”

*You can listen to the full podcast with Stuart Edwards here

**Source: Fund factsheet, 30 April 2023

_{Photo by Kittitep Khotchalee on Unsplash}