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The global pandemic has accelerated growth in certain sectors and industries such as digital payments, e-commerce, data centers, telemedicine and video gaming, with disruption timelines shortening. This trend is positive for our active Emerging Markets Equity Strategy, as we have always been forward looking, focused on many of these structural growth areas. As a result, we currently see that positive prospects for many of our portfolio companies actually accelerated. It is important to note that as COVID-19 unfolded, significant market turbulence disproportionately affected small- and mid-cap stocks in emerging markets, as is often the case in times of heightened risk. As markets normalize, we believe it is reasonable to expect relative outperformance from these smaller stocks. As a “true” all capitalization emerging markets equity portfolio, these changes in sentiment can materially affect the relative performance of the portfolio.
As the second quarter unfolded, so did easing of COVID-19 restrictions across emerging markets, and where possible, emerging markets governments continue to be accommodative on monetary and fiscal policy. For China specifically, we believe there is an increased level of confidence and a clear economic recovery. Although relatively prudent compared with many other developed and emerging markets economies, we expect continued loose monetary and fiscal policies. We are very cognizant of the negative political attitude prevalent in the United States towards China. We assume stasis in trade deals and a continued bifurcation in terms of technology and capital markets. This is disappointing but creates as many opportunities as challenges, in our opinion. We assume, as a minimum, that the rhetorical heat will be turned up as we approach the November election season, but we do also expect actual punitive actions to be much more restrained.
India continues to struggle with key risks to the medium-term growth outlook: 1) the pandemic not being brought under control, leading to the potential for another wave of shutdowns; and 2) domestic financials sector risk, as a result of a lack of a significant credit-off take from government credit guarantee schemes and build-up of perceived risks in the system, with regulatory forbearance leading to moral hazard and higher non-performing. Brazil experienced a sharp contraction of activity as a result of political noise and failure to deal with pandemic challenges, contributing to the overall market volatility.
Clearly, we are in extraordinary times. 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 in the first stages of the pandemic was generated by the abnormal strength of the U.S. dollar, driven by a global “shortage” of dollars. Aggressive central bank action has “normalized” the situation and we continue to have a reasonable hope for U.S. dollar stability (or, dare we say weakness) in the coming quarters. Whilst it may not matter in the shorter term, we think emerging markets currencies are cheap, particularly versus the U.S. dollar.
Whilst the overall impact of the pandemic has been negative across many parts of the equity asset class, we believe 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. As the shorter-term distress and volatility recede in the face of truly impressive monetary and fiscal responses, 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 exactly how business will recover, we can say, with conviction, that the Strategy is well positioned for the future of emerging markets.
Quarterly returns are not annualized.
*All country and company weightings are as of 30 June 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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