Emerging market investing in today’s world


1 Jul 2024

Dan Mikulskis is chief investment officer of People’s Partnership, the provider of The People’s Pension.


Web Share

Dan Mikulskis is chief investment officer of People’s Partnership, the provider of The People’s Pension.

The term “emerging markets” began life in the World Bank in the early 1980s as a way to change the perception of developing countries and it has since stuck big time. 

Over the past four decades, this term has gone on to define an entire branch of the financial industry. It’s impacted the way firms are organised and run and you might say has been one of the most successful brands in the industry…until it wasn’t.

Zooming out to look at the performance of emerging market equity indices compared to developed markets (DM) since the inception of the EM “idea” reveals a slight outperformance for EM.

But it hides some huge cycles. With all of that outperformance coming pre-2010, followed by a now 15-year losing streak compared to DM. Many asset owners, including some prominent UK master trusts, have abandoned the allocation altogether.

As a global asset owner, we define our opportunity set globally and EM is a part of that, but what’s gone wrong with EM over the past two decades?

Four things stand out – there is the fact that emerging economies don’t tend to emerge. The developed/emerging paradigm is superficially persuasive, but it doesn’t stand up. Over the decades only a small handful of emerging countries have moved into the developed categorisation (Portugal, Greece and Israel). A two-state model of development is not accurate for today’s landscape and hasn’t been true since the 1960s, with a four-state model being a better fit.

Countries like China and India have moved up the rungs of that ladder, but have not, and may never follow exactly the path to development and open markets of today’s developed market countries.

The myth that growth translates to investment returns is propagated implicitly or explicitly all the time. EM is where the growth and population will be, so you want to invest in the companies listed in those markets.

But sometimes it doesn’t work like that. Economic growth accrues to non-listed firms, while listed firms are often those whose best growth days are behind them. Listed companies in EM also have the habit of diluting investors unfavourably through new issuance, so even if revenue and earnings grow, earnings per share does not.

Emerging markets hold the promise of a rich variety of markets from commodity exporters to tech innovators across many geographies with different challenges and opportunities. The trouble is the main indices have been driven by the performance of one country in recent years and for better or worse that’s China.

There are reasons to be optimistic on China, but understandably allocators might want to limit exposure to a bet on a single market, and one that is subject to authoritarian and not necessarily market-friendly rule.

When you look at the countries that form the bulk of emerging market indices and portfolios, these aren’t the countries at the early stage of development. They are pretty much all sitting on the third of four tiers: China, South Korea, Brazil, Malaysia, etc.

The way the index providers handled Russian stocks in the wake of that country’s invasion of Ukraine is a new risk hanging over a significant part of the EM space. What happened was a forced de-listing of all stocks at zero value, which has had repercussions elsewhere.

If investors assign some probability of stocks going to zero due to a non-economic, potentially political impetus that is going to drive pricing and crucially, the reassessment of that probability may drown out fundamental factors. The superficial “cheapness” of EM may owe a lot to this hard-to-price risk.

Where does this leave allocators who believe in the idea, but are struggling with the challenges? We need a new paradigm.  

One issue I often find is the market is set up to push products out in recognised packaging without stopping often enough to ask if that’s what allocators want (I heard a CIO at a conference make the acerbic observation that the industry has a lot of great sausage machines but rarely stops to ask if people still want sausages). Emerging markets is an example of this.

This could change. New data can be introduced. For example, weighting based on measures of freedom to address autocratic risk. Factor approaches, quant, custom indices and fundamental active can all offer something different. 

Another approach would be to redefine EM through the building blocks by looking at regional or country-level allocations. Some characteristics go beyond geographic definitions: maybe thinking in terms of commodity exporters vs importers and debtors vs creditors can help build more rounded, robust emerging market portfolios.

We like the idea of emerging markets and there are plenty of scenarios that could see it do well – a weakening dollar and/or a commodity exporting cycle could favour many companies listed in that universe as could a tech or green energy boom (think chips, batteries, solar panels).

New ideas are needed to make this allocation work for investors.


More Articles


Subscribe to Our Newsletter and Magazine

Sign up to the portfolio institutional newsletter to receive a weekly update with our latest features, interviews, ESG content, opinion, roundtables and event invites. Institutional investors also qualify for a free-of-charge magazine subscription.