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December 10, 2019

Source: The Globe and Mail
By: Joe Schlesinger

During the past decade, the world’s middle-class population has doubled to 3.6 billion people. China and India alone – the two largest emerging-markets (EM) nations – contribute to about 60 per cent of that growth, according to a report CaixaBank Research published in September.

By 2030, the report says that another billion people in China and India, are expected to join the middle class accounting again for 60 per cent of global growth. Does the disposable income and size of this new middle class make emerging markets a promising investment play?

Emerging markets have been a rough ride for buy-and-hold investors despite their expanding consumer base, says Hardev Bains, president and portfolio manager at Lionridge Capital Management Inc. in Winnipeg. “Over the years, people have thought that growth would go to the moon.”

Instead, investors have been on a roller-coaster ride. From 2000 to 2007, the MSCI Emerging Markets Index grew by almost 400 per cent. It fell precipitously during the global financial crisis in 2008-09, losing more than half its value, only to almost fully recovery by 2011. Since then, the index has made modest gains, with plenty of turbulence along the way.

Consequently, dollars invested in 2009 would have yielded just a 3.78 annualized return. By comparison, the S&P 500’s annualized return over the past decade is about 14 per cent.

Despite emerging markets’ lacklustre investment performance, many financial advisors remain optimistic. So does the International Monetary Fund. Its fall outlook says that emerging markets will lead regions in gross domestic product (GDP) growth for the next five years, averaging about 4.5 per cent.

“Emerging markets hold a lot of potential, especially for younger clients with longer investment horizons,” says Wilkie Kam, vice-president, senior investment advisor and associate portfolio manager with the Wilkie Kam Investment Advisory Team at BMO Nesbitt Burns Inc. in Vancouver.

Although emerging markets’ growth potential is unlike anything investors have seen in modern history, their markets will continue to be prone to high volatility. As Mr. Kam says, emerging-markets companies are more prone to government intervention and currency value swings, which can send stock prices surging and plummeting all within a few months.

So, where should investors turn? Mr. Bains suggests seeking exposure through multinational companies headquartered in North America and Europe. Among those is U.S. consumer staples company Mondelez International Inc. (MDLZ-Q), which makes Oreo cookies and Ritz crackers.

What Mondelez also has is international brands we don’t see in North America, which are consumer staples in Latin America, Asia and the Middle East.

“And the advantage of a company like Mondelez is scale and know-how with production, shipping and marketing,” Mr. Bains says.

More than one-third of Mondelez’s revenue now comes from emerging markets. For multinationals in other sectors, including health care, emerging markets also make up a large share of revenue. Mr. Bains points to Medtronic PLC (MDT-N), the world’s largest medical device maker. It reaped about US$4.7 billion from emerging markets in its 2019 fiscal year, a 6.3 per cent year-over-year rise.

Mr. Kam says advisors seeking direct access for clients to emerging markets should look to large companies based in those markets that are listed on U.S. exchanges, like Alibaba Group Holding Ltd. (BABA-N) and Tencent Holdings Ltd. (TCEHY-OTC). For more diversified exposure, advisors should look to funds investing in emerging-market domestic stock exchanges.

Active funds often have teams of analysts on the ground in emerging markets, visiting companies to assess their value. Among them is Fidelity Investments’ Frontier Emerging Markets Fund team, led by portfolio manager Adam Kutas. The fund offers a different take by focusing on less-developed emerging markets.

China, India and nations such as Taiwan and South Korea tend to dominate emerging-markets’ indices. Mr. Kutas says exposure through exchange-traded funds (ETFs) that track these indices can result in owning very little of the major growth opportunities under way in economies such as Vietnam, Kenya and Bangladesh.

To Mr. Kutas, only active funds can focus capital on potentially lucrative companies in such markets. One example: Safaricom PLC, Kenya’s largest mobile network operator, he says.

“Almost half its income is from money transfers … with about 10 per cent of the nation’s GDP going through its network daily,” Mr. Kutas says.

The performance of active funds relative to their high management expense ratios (MERs) may not appeal to thrifty clients. Fidelity’s Frontier offering is one of the longest running emerging markets funds and it has a 2 per cent annualized return after fees since its inception in 1994. However, the fund has experienced periods of outlandish returns, gaining about 500 per cent between 2002 and 2008.

Alternatively, plenty of low-cost ETFs focus on emerging markets. “However, not all ETFs are created equal,” says Elisabeth Kashner, director of ETF research at U.S.-based FactSet Research Systems Inc.

She says many can be costly relative to developed market offerings. Of the 84 emerging-markets ETFs trading in North America, only seven have MERs of less than 0.2 per cent. The majority charge MERs of 0.5 per cent or more. As well, more than a third are at risk of closing due to low demand.

Still, the largest offering – iShares Core MSCI Emerging Markets ETF (IEMG-A) – has more than US$57.5 billion in assets under management, with a 0.14 per cent MER. Additionally, investors can access emerging-markets ETFs with exposure to small-cap stocks dividend-yielding stocks, bonds and even real estate.

Regardless of the assets, the objective is the same: capitalizing on hundreds of millions of people entering the middle class annually.

“The question is really how you want to get your clients that exposure,” Mr. Bains says.

Source: https://www.theglobeandmail.com/investing/globe-advisor/advisor-news/article-with-the-rise-of-their-middle-class-is-it-time-to-invest-in-emerging/