For investors looking to add spice to their portfolios by investing in a single-country fund seeking to profit from trends in fast-growing economies, which of the big three emerging market regions looks the best option? Ceri Jones weighs up the pros and cons.
Emerging markets across Asia present a tremendous opportunity as they boast growth rates of as much as 7% to 8%, and are no longer just cheap manufacturers, but have themselves become enormous markets for consumer goods.
They are also in much better shape than developed economies regarding inflation, as their central banks started raising rates a year before the West, and most governments did not furlough their citizens or overstimulate their economies.
Each market has its own specific structural trends. For example, India and Vietnam have very young populations with middle-class aspirations, while China has become an ageing population and its growth in contrast is more likely to come from increased spending by affluent customers on premium goods and services.
Javier Garcia, portfolio manager of emerging markets equities at Berenberg, points out the global middle class is expected to grow from around 2 billion in 2020 to 3.5 billion in 2030.
He notes: “A large proportion will be in emerging economies in Asia, which should lead to further increases in domestic demand.
“The wealth of resources, qualified workforces and ecological diversity provide a solid basis for stable growth. This trend is set to benefit Vietnam and India, where the median age in 2021 was 27.6 years and 32.5 years respectively.
“These two countries are filled with young people who, among other things, want to travel, need education and bank accounts, and are potential users of social media.”
India’s very favourable demographics
As many as a quarter of the world's under-25s live in India. “It is a story about the middle classes coming though over the next decades,” says Nick Payne, global emerging market equity specialist at Jupiter.
Payne adds: “This is very different from China where the population is aging more rapidly than thought, which means people with high levels of savings who can spend more on premium consumption – such as discretionary staples and high-end tech.
“Premium products like those spurring growth in China have held up better around the world since Covid, but growth is now likely to be stronger in India, where a long tail of growth is set to come through.”
In addition to India’s demographic premium, many of prime minister Narendra Modi’s reforms over the last eight years are beginning to have an impact, such as the unification of taxes into a single digitalised successor to VAT, the Goods and Services Tax. Demonetisation is also an advantage – for example, customers can pay by QR code even at market stalls.
However, political uncertainty and corruption have hampered progress in the past, and India’s success could be de-railed by the general election next year, although Modi remains favourite to be re-elected.
“As per United Nation estimates, India will have the most favourable demographics among the large economies over the next two decades,” says Ayush Abhijeet, adviser to the Ashoka India Equity Investment (LSE:AIE) Trust.
He says a potential multi-decade growth opportunity is unfolding, as per capita incomes rise, allowing domestic consumption to flourish.
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Abhijeet adds: “New-age consumption is just one of many trends set to drive emerging markets. Additional ones include digitisation, decarbonisation, healthcare technology and supply chain reorientation. India is one of few economies internationally that offer exposure across all these.
“For example, as supply chains adjust post-Covid and in light of the geopolitical environment, where companies are looking for sourcing optionality outside China, India’s adherence to global manufacturing standards and strong intellectual property rights protection makes its businesses one of the credible emerging suppliers.
“This is just one example of how a series of structural reforms and initiatives implemented by the Indian government has enhanced the ease of doing business within the country.”
India is relatively under-researched and therefore a perfect destination for active managers. The Jupiter India fund run by Avinash Vazirani has had success in small and medium-sized companies that are sometimes overlooked. While small-cap prices have been weak for a few years impacting performance, a readjustment is inevitable at some stage.
Poor governance is another of the risks of investing in emerging markets. Stewart Investors Indian Subcontinent Sustainability fund, which invests primarily in India, but also Pakistan, Sri Lanka and Bangladesh, has an emphasis on stewardship and good governance. It is a high conviction fund, top 10 holdings usually account for more than 40% of the fund’s value, which can therefore look very different to the benchmark.
Caption: Mumbai skyline
China has plenty of long-term appeal
China is cheaper than India, however, trading on a price/earnings (P/E) multiple of 12x to 14x, compared with 26x for India. More recently, after the initial optimism of China’s reopening after three years of zero Covid tolerance, a degree of disappointment and realism has set in.
The geopolitical situation is also a headwind, and China’s fractious relationship with the US is not going to go away in US election year. No presidential candidate will score points with voters for appeasing President Xi Jinping.
Longer term, however, China has a lot to offer. Asia’s growth has been significantly driven by high-end chip and semiconductor production, and China still shines here.
“Developments such as cloud computing, big data, Internet of Things and most recently artificial intelligence will continue to have a positive impact,” says Garcia.
He adds: “Of the three countries, this trend has benefited China most, particularly when it comes to semiconductors. China was the world’s largest semiconductor market in 2022 with sales of $185.5 billion, and yet its growth prospects are still astonishing, particularly in the semiconductor design market where the country’s global sales revenue is projected to increase from 9% in 2021 to 23% in 2030.”
China’s big ambitions to become carbon-neutral by 2060 have also spurred developments in solar, wind, hydro and electric vehicles.
Garcia points out: “China is the world leader in the manufacture of solar panels, with market share exceeding 80% in all manufacturing stages.
“China also made up 53.3% of the total sales for electric vehicles worldwide, showing it has a strong foundation for key markets that will drive the energy transition.”
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Ian Samson, portfolio manager of multi-asset at Fidelity International, notes that while China, India and Vietnam all have their pros and cons “on balance we prefer a long-term investment in China's equity market”.
He adds: “Short-term fundamentals do look a little better in Vietnam and India. However, the longer-term growth story of China is undeniable, even if the initial burst of activity following China's Covid re-opening has lost momentum. Furthermore, current equity valuations in China are more attractive than those of Vietnam or India.”
Investors would do well to pick a fund that invests in A-Shares listed on either the Shanghai or Shenzhen stock exchanges, which are accessible only to Chinese citizens, particularly as the A-Share market is uncorrelated to other emerging markets and improves a portfolio’s diversification. Allianz China A-Shares Equity fund has performed well and focuses on sustainable growth businesses at reasonable valuations, with decent cashflows and little regulatory risk in their sectors.
Among investment trusts, Fidelity China Special Situations (LSE:FCSS) can make use of Fidelity's extensive investment licences in China. Experienced manager Dale Nicholls has a bias towards smaller and medium-sized companies with greater growth potential but higher risk. This investment trust is one of interactive investor’s Super 60 investment ideas.
Caption: a wind farm in Vietnam
The case for ‘plucky outsider’ Vietnam
Both India and China have massive populations of 1.4 billon apiece, dwarfing Vietnam which has a population of just 100 million. Vietnam is nonetheless growing rapidly and is a major beneficiary of the widening of the supply chain with its labour cost advantage. Many businesses have been choosing Vietnam as a safer or second Asia option for manufacturing and product assembly, rather than China, which disrupted supply chains with its border closures and lockdowns.
“In sheer economic terms, Vietnam is at best a plucky outsider, yet this is a role it fulfils with vigour, with a youthful population giving demographic advantage over its neighbours and regional peers,” says Edward Allen, investment director at Tyndall Investment Management.
He continues: “Leaving all else aside, and assuming they all have exciting corporate earnings growth targets, I would pick Vietnam over China and India. Vietnam is cheap and has just suffered a catastrophic bear market, falling by 34% in 2023, and it should continue to benefit from both proximity to China and low-cost work force.”
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Allen’s choice for exposure to Vietnam is Dragon Capital’s listed Vietnam Enterprise (LSE:VEIL). He says it is “a steady outperformer and conservative steward of capital in what can be a wild west of a market.” Its current discount, as at 1 August, is 9.8%.
The other investment trust option is VinaCapital Vietnam Opportunity Fund (LSE:VOF). This fund pays dividends, currently yielding 2.8%. Its on a higher discount of 13.8%.
In terms of performance, it is very similar over three years, with both trusts up around 66% to 67%. Over five years, VinaCapital Vietnam Opportunity Fund has the edge, up 68.2% versus 50.3% for listed Vietnam Enterprise Investments.
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