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EM Equities: Middle-Income Trap, Tapering, and Frontier Markets in 2014

Emerging Markets versus Developed Markets

DAVID SEMPLE: I think one of the things that may happen is that the differential in growth between emerging markets and developed markets will contract.  Emerging markets will still be growing but their excess in growth over developed markets will be less.

Escaping Middle-Income Trap

SEMPLE: There is a longer-term issue in EM with how countries escape from the so-called middle-income trap where you get the benefit of globalization, cheap labor and technology, but those tailwinds are lessening and now those countries need to pursue the hard stuff: reforms to increase the ease of doing business, investments in soft infrastructure such as education and healthcare, etc. Some countries will do it well and some will not. < /p>

Over time, we think that there will be increasing idiosyncrasies from country to country.  Allied to that is the effect of tapering which should sort out which countries are stronger than others.  Our thesis last year was to not see emerging markets as a beta block but rather as a collection of countries where we can pick the best stocks. This has been and continues to be very successful for us.

Effects of Tapering

SEMPLE: I think we had a situation last summer in which people panicked a little bit about the effects of tapering. I think that as we go into tapering, the world's not going to end.  What you're going to have is an echo effect, and I think that will have an increasingly focused impact on emerging markets.  There's no doubt that there is money that has flown into emerging markets, particularly on the debt side. Foreigners also hold a high level of bonds in certain places like Malaysia, Indonesia, and so forth, compared to what they have had in the past.  

Some countries that were affected in the past will do relatively better this year.  I would point to India, for instance.  I think the political situation in India is very interesting, and perhaps we might get some more reform-minded politicians that are actually able execute better than they have in the past.  The central bank governor is a good start.  Overall, we like the situation in India.  We want to be more or less hedged with the currency but our stock selection should be relatively less affected this time.

Frontier Markets

SEMPLE: We definitely think that there is some alpha to be had in frontier markets [Nigeria, Saudi Arabia, Thailand, etc].  The frontier markets clearly had a good year 2013.  We think that it's rather artificial to create a line between developing markets and frontier markets.  Frontier markets for us share a lot of the same characteristics as emerging markets and in many respects, they're more different from each other than they are from the emerging markets.  We've always been active in frontier markets as part of our strategy. Where we see opportunity to invest in good companies and good situations, we will absolutely do it as part of our larger market strategy rather than creating two artificial buckets of countries.

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