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The economic healing from the effect of Covid continues. The economic recovery in emerging markets (EM) countries remained strong throughout September 2021. Going forward, we believe that the easing of lockdown measures, coupled with strong developed markets (DM) growth, should support EM recoveries over the remainder of this year.
The shifting landscape of regulatory action and property angst in China were widely discussed, but not always understood. China’s economic “miracle” of lifting the vast majority of its population out of poverty has come at a breathless pace relative to the similar development paths of more mature economies. That pace has left gaps where commercial enterprise has been allowed to thrive relatively unfettered by regulation. In part, the flurry of new rules can be seen to be a “catch up” to create a better long-term environment for many industries. In a sense, the impetus has shifted from just growth to both sustainability and growth. Left unchecked, some companies have taken full advantage of grey space, but now find some of their activities to be on the wrong side of the increasingly clear hard lines of regulation.
One frustrating aspect of new regulation in China is the method by which changes to industry rules happen. There is very little in the way of iterative, public hearing-type processes and analysts are often restricted to the parsing of political signs to anticipate changes. Often, we know that an industry is in the spotlight, but putative changes are not bounced off the walls of popular and market opinion and, frankly, they are not subject to a very transparent political process. In addition, many new regulations have lacked specific implementation detail, prolonging uncertainty. And as we know, global financial markets do not respond well to uncertainty.
Taking a step back, whilst criticism for implementation may be valid, the goals are not too dissimilar from much that is happening in the developed world:
A widely known, and incredibly predictable challenge for China, is demographics. The population is rapidly aging. The fertility rate is low. The cost of raising a larger family can be daunting, particularly as it relates to the “three mountains” of costs associated with childcare—education, healthcare and housing. In part, some recent changes are designed to address those challenges, and attempt to create a more equitable society.
China’s Property Development—The Evergrande Case. It is important to note that the VanEck Emerging Markets Fund Strategy does not have any direct exposure to Evergrande. In China, our only real estate position is A-Living Smart City Services Co., Ltd. (2.06% of Strategy net assets*), which is a property management company, not a developer. We expect government action to ensure orderly liquidation of Evergrande. No explicit bail out, but support for the most important stakeholders, the property buyers. Given the importance of property activity and prices in GDP and consumers’ net worth and psyche, the longer the uncertainty persists, the more effect it will have on general consumption. This exacerbates an economy slowing domestically for a combination of reasons, including Covid outbreaks, decarbonization efforts and the well-known micro tightening (regulations). All the above argues for caution in the shorter term, whilst being alive to very stock-specific opportunities, where prices are already discounting very bad outcomes.
As a result, the opportunity set is even more company-specific in China and in the rest of emerging markets. It is true that many regulations may ultimately create a better end point of fairer, more sustainable industries, but the journey can be arduous and uncertain. Investors don’t like uncertainty. In addition, for a number of the more recent China related listings in the Internet space, we question the moats1 of their business models.
In summary, we believe the macro environment, with subdued inflation and low rates, even as global activity normalizes, may be rewarding for forward-looking, sustainable and structural growth investors in emerging markets. But the focus has to adjust to a landscape of changing regulatory and industry dynamics, potentially creating a compelling, alpha generation opportunity for active investors in the space.
On a more positive note, trends across non-China EM are mostly quite optimistic, as vaccines roll out and economies reemerge from lockdown. A combination of increased demand, lower rates, supply demand asymmetry and accelerated digital adoption have driven the earnings and share prices of many of our portfolio companies, from Reliance Industries Limited2 (India’s leading retail, communication and e-commerce business), to Sea Ltd.3 (an e-commerce platform across ASEAN), to Movida Participacoes SA4 and Vamos Locacao de Caminhoes5 (Brazil’s sustainable transportation companies). Many countries like the Philippines, Thailand, Indonesia, Brazil, etc. have not yet felt the full impact of decreased Covid risk and we expect continued strong performance from our investments in these countries, which were slower to throw off the very negative effects of the worst of this pandemic.
We believe the asset class is unloved, in particular because of the exceptional bounce in U.S. economic activity and improvement in the U.S. dollar’s performance, coupled with a more optimistic outlook for the Eurozone as well. This sets up an interesting environment where U.S. economic exceptionalism fades, China “eases” (at the margin) its micro tightening and the rest of emerging markets catch up with vaccinations and economic mobility.
So far this year, the “toggle” between growth at any price and low quality value has not done any favors to our Strategy, which is guided by the philosophy of forward-looking, sustainable and structural growth. However, after an active quarter, we feel very excited about our holdings and strongly believe that we are well positioned with compelling, stock-specific opportunities in a diversified portfolio that fits nicely into the evolving emerging markets investment landscape.
1 A moat is a sustainable competitive advantage that is expected to allow a company to fend off competition and sustain profitability into the future.
23.98% of Strategy net assets as of 30 September 2021.
32.20% of Strategy net assets as of 30 September 2021.
40.93% of Strategy net assets as of 30 September 2021.
51.22% of Strategy net assets as of 30 September 2021.
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