Investors seduced by the impressive growth forecasts for emerging market economies should prepare themselves for a bumpy ride.
Global consumption is predicted to double to £64trn between 2013 and 2025, according to McKinsey. The consultancy adds that half of this growth in demand for goods and services is expected to come from developing nations.
Younger populations and rising urbanisation are just two reasons for such a forecast and underpins the investment case for emerging market companies. Yet the countries they operate from are no strangers to volatility and, as I write, they are having another wobble.
Argentina’s debt woes are rarely out of the business pages and Turkey has been struggling under the strain of huge foreign currency borrowings and inflation marching towards 20%. Add to that South Africa surprising many by entering recession as well as fears of further sanctions against Russia and investors are getting a little jittery about their emerging market holdings. News that China will have to pay higher taxes if it wants to sell some of its goods in the US has not helped fund managers in their attempts to ease such fears.
These concerns are understandable. Many emerging market companies are young and, therefore, riskier. But there are signs of maturity. Some companies have strong balance sheets and rising earnings as directors ignore the noise around the political situation in other emerging countries and focus on serving the favourable demographics in these regions.
This has led to emerging markets’ output no longer being focused on commodities. Technology, healthcare and leisure are growing industries as companies not only target the local middle classes, but developed market customers too.
There are, however, justifiable concerns over liquidity, especially when it comes to fixed income. Corporate governance is another issue, but, as we explore on pages 26-29, there are signs of improvement.
So emerging markets and bad news do not make comfortable bedfellows, but long-term investors should not be too concerned by short-term turbulence. As long as the investment case has not changed, it could be an example of volatility being your friend and take advantage of improving valuations.
If the forecasts for emerging markets prove correct, can pension schemes hungry for growth really afford not to have any exposure to the asset class? Investors may have to ignore the short-term pains in order to collect the potential long-term gains.