Emerging Market (EM) economies are developing nations which are growing quickly and will, ideally, become more integrated into the global economy over time. EM economies are often characterized by higher economic growth and population growth. This combination creates an environment in which companies and industries can grow rapidly as the broader economic and financial system develops.
Navigating the complexities of emerging markets is notoriously difficult, but it holds great opportunity for growth and diversification. While the prospective returns of higher growth economies are alluring, complexities in the global economy cloud the simple assumption that higher GDP growth translates into higher earnings and market returns. Therefore, it is imperative to be conscious of the political and economic background of underlying investments in emerging markets. These factors are a primary reason we view active management as essential to EM investing.
Our research suggests EM equities may be attractively positioned; EM equity valuations are attractive relative to the United States, with the spread between these two entities at its widest in two decades. Additionally, earnings for EM equities have fallen since 2021. Because of these factors, the EM index is ~30% away from its peak in 2021. While there are many factors which catalyzed this decline, high inflation, a risk-off mindset in investors, and the dollar’s strength played roles in burdening EM equity returns. A reversal in these trends would likely be large tailwinds to EM economies and offer great opportunity for return.
Specifically, the U.S. dollar’s strength, relative to other currencies, weighs on EM economies. However, we see the potential for the dollar weakening as it is currently very elevated against other currencies. Other countries have also begun to slowly diversify away from the dollar, suggesting demand for the dollar may be at risk over time. If the dollar does weaken, the opportunity in emerging markets would likely be increased. Nevertheless, if these macro-tailwinds do not play out, proper active management, which is focused on more idiosyncratic opportunity, can offer opportunity for return and diversification.
Data Source: Bloomberg
Another benefit of exposure to EM equities is the diversification of portfolios. Different investments are affected differently by various economic conditions or market trends. Diversification works to reduce risk in portfolios by allocating capital to various asset classes, geographies, and industries. By investing in EM equities, we have the ability to increase the diversification of client portfolios and gain exposure to various new opportunities.
As always, Acumen is dedicated to uncovering opportunities to protect capital and grow assets. We believe prospective economic growth, attractive positioning, and potential macro-tailwinds, all work to present the opportunity available in emerging markets. The opportunity provides portfolio diversification benefits and a potential for growth, and we believe an astute actively managed approach could capture these benefits.
Information used in this commentary was obtained via Bloomberg L.P.
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