Alistair Way, head of emerging market equities at Aviva Investors, looks at three themes that will shape the asset class in 2021.
1. As economies begin to recover and markets normalise in the wake of the COVID-19 pandemic, top-down thematic trends will give way to a more diverse range of performance drivers. Stock selection will become more important for investors in EM equities.
Global emerging market equities have proven relatively resilient through the turmoil of 2020. In dollar terms, the MSCI Emerging Markets Index returned 1.15 per cent over the year to October 30, outperforming both the MSCI World Index (-0.98 per cent) and the MSCI All Country World Index (-0.68 per cent). But these figures mask some important nuances.
Growth has come mostly from internet and broader technology stocks
As with developed markets, EM equity performance this year has been driven by a handful of stocks in a handful of sectors in a handful of countries. Growth has come mostly from internet and broader technology stocks in the larger, richer emerging economies: China, South Korea and Taiwan.
Many investors have understandably sought to navigate the market chaos of 2020 by allocating capital based on top-down thematic trends, principally the global rise in demand for digital platforms during lockdowns. This has benefited companies in communications software, gaming and e-payments, among others. One indicator of this trend is that China’s tech-focused equity index, the ChiNext, rose an astonishing 50 per cent in the year to October 30.1
But as COVID-19 vaccines are rolled out and economies recover, we expect to see less emphasis on thematic trends and a more diverse range of performance drivers return in 2021. As economies will recover at different speeds, investors will need to monitor the state of the pandemic and policy responses in each country to properly assess potential opportunities. This environment should favour investors willing to go off the beaten track and undertake bottom-up due diligence on companies in previously overlooked markets. Opportunities may arise in South Asia and the frontier markets of sub-Saharan Africa, which have thus far weathered the pandemic better than expected.
2. The trade war will persist and globalisation will continue to unwind. Sanctions-hit companies will suffer; others could seize the opportunity to build market share.
A new US administration under President-elect Joe Biden is unlikely to bring an end to the US-China trade war. While Biden can be expected to seek a more rational, measured and multilateral approach to containing China than his predecessor, President Trump, tensions between the two global powers are likely to continue. There is even a risk Trump may take the opportunity to enact hawkish anti-China legislation during his remaining time in office, making it difficult for Biden to deescalate the conflict early in his term without looking weak.
China is aware it needs to accelerate efforts to achieve self-sufficiency in chip-making and other vital technologies
Against this backdrop, China is aware it needs to accelerate efforts to achieve self-sufficiency in chip-making and other vital technologies. The government will continue to offer subsidies to homegrown players. Meanwhile, smartphone maker Huawei has been badly damaged by restrictions on its access to American-made semiconductors, which constrain its ability to build competitive handsets. It has already started to lose customers domestically and will face further challenges in 2021.
By contrast, some other emerging market companies have proven they are able to adapt to the shifting geopolitical landscape and build market share as their peers are hit by sanctions: Korean electronics giant Samsung and Taiwan-based chipmaker TSMC managed this impressively in 2020.
3. China’s decarbonisation push will benefit the renewable-energy and EV sectors, both domestically and in neighbouring markets.
In September 2020, Chinese President Xi Jinping announced a set of ambitious climate targets: he pledged China would hit “peak carbon” in 2030 and cut emissions to near-zero by 2060. To meet these objectives, China will need to rapidly phase out coal-generating power plants and build renewable-energy infrastructure.
The decarbonisation effort is likely to accelerate demand for EVs in China
This policy programme should benefit a wide range of Chinese firms, including solar-glass manufacturers, onshore wind-farm operators and gas distribution companies. The decarbonisation effort is also likely to accelerate demand for electric vehicles (EVs) in China.
Equity valuations among many emerging market EV brands already look excessively high, but the knock-on effect on industries further down the supply chain, such as battery materials manufacturers, could generate attractive opportunities in China and other major emerging markets, notably South Korea.
Macro themes, such as the trade war and the battle against climate change, will continue to shape the EM landscape in 2021. But as the global economy begins to normalise in the wake of the COVID-19 pandemic, investors will also need to attend carefully to the differences between emerging markets and the dynamics of individual economies and companies.
To capture the full range of opportunities, investors should look across the EM spectrum and focus on fundamental valuation considerations. Careful due diligence and disciplined stock selection will be crucial.