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As the beginning of the year and the quarter unfolded, so did the global reach of COVID-19 and its impact on emerging markets’ economies. Looking at some of the countries in which we invest, China remains an important case study. Economic activity dropped dramatically but there are clear, tangible signs of recovery, although “back to work” is much more robust than “back to play.” India had some challenges to overcome, particularly in its financials sector, even before the costs of the pandemic are considered. The shutdown and the impact on the economy and credit costs will exacerbate the situation. Whilst the Emerging Markets Equity Strategy does have the financials exposure in India, it is focused on what we believe are “best of breed” companies, like HDFC Bank, that ultimately benefit from these tough times. In Brazil, political noise has become louder and the market has been volatile.
The consequences of a global pandemic juxtaposed with truly unprecedented monetary and fiscal stimuli will be with us for many years to come. Emerging markets have traditionally underperformed in a risky environment but, in general, we believe the behavior of the asset class has not been as bad as many might have predicted. A large part of the negative outcome was generated by the abnormal strength of the U.S. dollar, driven by a global “shortage” of dollars. This has started to normalize and we continue to have a reasonable hope for U.S. dollar stability in the coming quarters. Whilst it may not matter in the short term, emerging markets currencies are cheap, particularly versus the U.S. dollar.
Whilst the overall impact of the pandemic has been very negative across all equity asset classes, there is some silver lining in a very dark cloud. The Strategy has always been forward looking, focusing on sectors and industries that form the future of emerging markets rather than the past. It is clear that the golden era of globalization has gone and concentrated supply chains will be increasingly questioned. The “business model” of many emerging countries as they progress from low to middle income was predicated on cheap labor and the comparative advantage that this endowed. Either that or as a supplier of significant commodity resources. We believe both “models” will be increasingly challenged in the future and successful emerging markets economies will be based on innovation, education, domestic demand and consumption. The Strategy continues to be heavily invested in the future of emerging markets, in industries that, we believe, match the likely route that the best economies may take. Industries such as healthcare, e-commerce and education may be the most fruitful areas of investment going forward, we believe. And one consequence of the pandemic is that it accelerates trends in some of these areas and changes behaviors towards increased consumption of certain parts of these industries. We believe the Strategy is well positioned for that future. Once the short-term distress and volatility recede as global government responses flow through the financial system, we expect bottom-up stock selection to drive alpha once again in emerging markets countries around the world.
Concurrent with their forward-looking business models, exceptional structural growth companies tend to have robust balance sheets, a feature which not only helps them to weather this particular storm but also take advantage of opportunities as the clouds lift.
Investing in emerging markets is for the long haul, and whilst we can’t say when business will resume, but we can say, with conviction, that the Strategy is very well positioned when it does.
Quarterly returns are not annualized.*All country and company weightings are as of 31 March 2020. Any mention of an individual security is not a recommendation to buy or to sell the security. Fund securities and holdings may vary.
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