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-Emerging markets have seen a significant economic hit from the pandemic
-Many emerging markets are recovering quickly from the economic weakness, particularly corporate earnings
-Reform is still a major driver for growth across emerging markets
Covid-19 has hit emerging markets every bit as hard as it has hit developed markets. While many have younger populations and therefore lower mortality rates, this has been offset by underdeveloped healthcare systems and constrained government finances. However, as and when the world starts to recover, emerging markets may have some natural advantages.
Like their developed market peers, emerging markets have seen economic damage from the pandemic. The figures, in many cases, make for uncomfortable reading. India, for example, saw its economy contract 23.9% from March to June last year. For Latin America, it was a similar picture. Peter Taylor, senior investment director on the Aberdeen Latin American Income fund, says: “We saw shocking numbers in terms of economic contraction, reflecting the global economic slump that we experienced across both developed and emerging markets.”
However, in many areas, there are signs of recovery. This is particularly true for Asia, where China’s rapid emergence from the virus has helped its economy revive, along with those of its neighbours. Gabriel Sacks, investment director on the Aberdeen Standard Asia Focus trust says: “There is an expectation that there will be a very sharp rebound for earnings as we enter 2021.”
That said, the recovery is not just confined to those areas that have successfully managed the virus. In Brazil, one of the hardest-hit regions from the crisis, earnings are being revised higher. Taylor says: “The speed at which the Brazilian economy normalised gives us cause for optimism. Consumption, for example, rebounded faster than expected and we have seen this feed through into the earnings for consumer companies, which are being revised higher.”
Debt levels
In general, emerging markets have not taken on the same government borrowing as developed markets. Many have not had deep enough pockets, or the same unfettered access to international debt markets. This has limited their ability to spend. This may be a disadvantage in the short term, but is potentially an advantage in the longer term as their economies aren’t weighed low by debt and they do not face the same cliff-edge drop as stimulus is withdrawn.
Emerging market companies also tend to be less indebted. Sacks says: “Companies are typically very disciplined when it comes to managing their balance sheets and capital allocation. Net debt to equity is a lot lower in Asia than it is in developed markets.”
Reform
There are other considerations that should favour emerging markets. Reform is still a major driver in many economies. In India, for example, we see continued reform to tackle corruption, promote financial inclusion and digitalisation. Kristy Fong, senior investment director at Aberdeen New India investment trust, says: “The government’s commitment to reform has been very consistent. This is the government’s second term and they have put through very difficult reform measures, which will be great for India in the long-term.”
In Brazil too, there has been a continuation of the reform agenda under Jair Bolsonaro in spite of the disruptive impact of the pandemic. Several reforms are currently under review in Congress, including a public sector reform bill to lower payroll costs and improve efficiencies; there are also plans to reform the complex and inefficient taxation system.
US election
The result of last November’s US election may also prove to be a game changer for some emerging markets. Firstly, a more stable and predictable approach to foreign policy should be better for everyone. While it is unlikely that President Elect Biden will fundamentally shift the US’s stance on China, he is likely to take a more measured approach.
Elsewhere, the advantages will be more apparent. Biden has a history of good relations with Latin America. Equally, the region may be a beneficiary of greater fiscal stimulus in the US, though the size may depend on whether Biden secures control of the senate following the run-off election in Georgia, underway at the time of writing.
Sacks says: “We expect Biden’s presidency to be good for emerging markets. A blue wave, where the Democrats won the Senate and Congress would probably have been better, but our expectation is that monetary policy and fiscal policy should remain loose, which should result in a weak dollar.” Taylor adds: “The most important thing is the end of uncertainty about the outcome. This creates a certain degree of visibility going forward.”
Valuations
Emerging markets also have more compelling valuations. While emerging markets have outpaced their developed market peers since the market turned last April, they had a long way to go to catch up. Over 10 years the MSCI Emerging Markets has delivered annual growth of just 2.4%, compared to 8.6% for the MSCI World. Equally, many of the early gains have come from China, which has left other emerging markets some way behind. There is significant scope to catch up.
That said, while this suggests a favourable backdrop for emerging markets, investors need to be active and to focus on quality. In this type of environment, the strong will get stronger. Fong says: “One of the opportunities we’ve seen is that in challenging times, strong companies get stronger as the weaker ones find it harder to survive.”
Important information
Risk factors you should consider prior to investing:
-The value of investments and the income from them can fall and investors may get back less than the amount invested.
-Past performance is not a guide to future results.
-Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
-The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
-The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
-The Company may charge expenses to capital which may erode the capital value of the investment.
-Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
-Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
-There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
-As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the
-buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
-The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
-Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate.
-With funds investing in bonds there is a risk that interest rate fluctuations could affect the capital value of investments. Where long term interest rates rise, the capital value of shares is likely to fall, and vice versa. In addition to the interest rate risk, bond investments are also exposed to credit risk reflecting the ability of the borrower (i.e. bond issuer) to meet its obligations (i.e. pay the interest on a bond and return the capital on the redemption date). The risk of this happening is usually higher with bonds classified as ‘sub-investment grade’. These may produce a higher level of income but at a higher risk than investments in ‘investment grade’ bonds. In turn, this may have an adverse impact on funds that invest in such bonds.
-Yields are estimated figures and may fluctuate, there are no guarantees that future dividends with match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments. You should obtain specific professional advice before making any investment decision.
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Find out more about Aberdeen Latin American Income Fund: www.latamincome.co.uk, Aberdeen New India Investment Trust: www.aberdeen-newindia.co.uk and Aberdeen Standard Asia Focus: www.asia-focus.co.uk.
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