Emerging Market Equity Positioning

LOOK EAST FOR GROWTH

The lion’s share of global growth today is being driven by Emerging Asia, and that percentage is only expected to grow over the next decade. Countries like China, India, Vietnam, and Indonesia sport growth rates that are large on both an absolute and relative basis, dwarfing those seen in developed markets like Europe and the United States, as well as in other non-Asian EM.

For investors with a long-term horizon, exposure to EM Asian equities would capture the bulk of these economies’ incremental contribution to global growth. The investment opportunity set is broad-based—Financials, Consumer Discretionary, and Information Technology companies account for a significant and rising share of these markets, which are increasingly driven by technological innovation supported by an emergent young, affluent, and aspirational middle class.

EM Asian countries have worked hard to diversify their economies. These nations are moving away from export-driven low-cost and labor-intensive manufacturing toward higher-paying value-added production and service-oriented industries. Improved government policy frameworks, structural reforms, technological innovation, and the growth of the middle class are all helping to build more sustainable sources of growth domestically. At the same time, there remains significant additional scope for long-term structural gains in productivity and competitiveness in relation to developed market nations.

The Asia story is driven fundamentally by favorable demographics, low debt and high savings/investment rates, competitive business environments, and strong integration in the global value chain. In terms of our key building blocks of economic growth, working age population growth, and productivity, Asia excels. Overall Asian population growth remains outsized, with the middle class alone expected to grow to 3,492 million by 2030 versus 525 million in 2009 and 1,380 million in 2015. Indeed, Asia’s expected 153% middle class growth rate during the 2015-2030 period will dwarf almost every other region of the world.

As the demographic dividends from a steady supply of young people entering the workface begin to kick in, this should help sustain growth rates, resources for investment, and consumption momentum. And, given that many Asian countries have not yet fully urbanized, there is considerable additional upside as more citizens shift from agriculture toward higher value-added manufacturing and service jobs. Greater urbanization is expected to further boost per capita incomes and productivity, which is what drives domestic consumption and demand and supports higher EPS growth and equity returns.

Similarly, overall productivity in the region remains substantially higher than in the rest of the world. Productivity growth is being boosted by strong investment rates as well as by competition within the business environment, which is incentivizing firms to evolve their processes or products to gain a competitive advantage. More than anything, Asia is marked by a growing culture of innovation and the region is quickly beginning to join the ranks of global leaders in technology research and development. For example, Asian investment contributed 40% of the record $154 billion in global venture financing in 2017, compared to just a 5% share 10 years ago.

All of this is occurring against a largely favorable policy backdrop. Asia generally has sound fiscal policies, which have helped to support growth. Efficient investments in public infrastructure provide more capital stock for workers to use, thus improving labor productivity. Meanwhile, the adoption of more liberal economic policies in the region is contributing to the development of freer markets and the emergence of companies with more stable business models. Better corporate governance typically shows up on multiple fronts. Balance sheets improve, debt can be issued over longer maturities at lower rates, resilience in periods of shock increases, valuations rise, and equity prices become more reflective of fundamentals.

Beyond strong internal demand, Emerging Asia has also been focused on strengthening interregional ties in order to expand into new markets and up the global value chain. Through trade agreements and cross-border infrastructure coordination, these efforts are helping improve efficiencies, connectivity, and investment flows throughout the pan-Asian economy. While in the past intra-Asian trade has been dominated by trade in components and materials that are assembled and then exported outside Asia, over the next 10 years, intra-Asian trade in final products and domestic demand is expected to drive growth. The U.S. decision to pull out of the Trans-Pacific Partnership (TPP) will only accelerate this trend. Indeed, while the U.S.-led TPP has faded into the background, the Chinese-led RCEP (Regional Comprehensive Economic Partnership) has gained momentum. Together with China’s “One Belt, One Road” initiative, RCEP should further bolster greater regional connectivity—not only within Asia but also with Europe and the Middle East.

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