Reasons why the perceptions of emerging markets are outdated

The underperformance of emerging markets versus global equities over the past three years has led investors to question whether the long-term prospects for emerging markets have changed.

The outlook is always evolving, but the long-term structural growth theme for emerging markets remains intact.  

The long-term case for emerging markets centres on superior growth, quality companies, and the large set of diverse investment opportunities.

Superior growth

Emerging market growth is driven by attractive demographics, rising investment that helps to create higher paid jobs, leading to an expansion of the middle class, and rising consumption. 

The UN projects the global population will increase by 2bn people to 9.2bn by 2050, with the majority of that increase in emerging markets.

While the global population will age, the working age population will increase to 4.25bn over the same period. 

The middle class in emerging markets will also expand dramatically over this period, as investment increases the demand for labour and more people move to cities.

These companies are the enablers of the fourth industrial revolution.

The urbanisation rate in emerging markets is forecast to increase from 51 per cent to 66 per cent by 2050. 

As the middle class in emerging markets expands, demand for consumer goods ranging from autos and air conditioners to tourism will rise significantly.

Auto penetration in emerging markets in 2022 was 119 per 1,000 people, compared to 497 in developed markets.

Quality companies 

Emerging market companies with the quality characteristics have increased over the past 15 years.

The weight of new economy sectors, which includes companies with quality characteristics, in the MSCI Emerging Market index has increased to more than 50 per cent over this period.

The weight of the old economy, including low return on capital companies, has declined to less than 20 per cent. 

Diverse investment opportunities

Emerging markets are home to some of the most exciting investment opportunities, including those in the electrification of transportation and the green revolution, such as renewable energy and battery storage systems.

These companies are the enablers of the fourth industrial revolution, which will focus on general purpose technologies and artificial intelligence. 

South Korea is at the forefront of these trends.

It is home to one of the world’s largest semiconductor companies, a sector that we think has a bright future.

Demand for semiconductors is forecast to grow in the coming years driven by demand for processing power to drive AI applications and the internet-of-things.

The 'China plus one' strategy should further benefit South Korean suppliers across sectors.

Continued technological development has led to higher silicon content per device, as well as the expansion of new end-applications (autonomous driving, generative AI), which drives continuous growth in semiconductor content.

Technology companies will drive semiconductor demand as they accelerate investments in AI.

Demand for evermore powerful semiconductors could increase dramatically in the years ahead as companies outside the technology industry also invest in customised large language models for their own use. 

South Korea is also home to companies developing the next generation of batteries that are powering the green transition in electric vehicles.

For batteries, we expect continued structural growth driven by increasing EV penetration as well as an evolving technological roadmap to drive demand, which South Korean manufacturers are well placed to meet.

South Korea also has several free trade agreements in place with key trading partners including the EU and the US.

Korean battery producers also met requirements under the recently implemented US Inflation Reduction Act, which makes them better positioned than competitors to meet US demand.

The 'China plus one' strategy should further benefit South Korean suppliers across sectors as countries globally look to diversify their supply chain away from China.

A new global trade landscape 

There has been some concerns over supply chains and rising geopolitical tensions, however with the increased focus on cutting-edge technologies, including AI and advanced semiconductor production, these are contributing to a reshaping of the global trade landscape.   

Emerging markets are under-owned, under-estimated and under-valued.

This is leading countries to accelerate efforts to diversify their trade relations and protect their supply chains. The US, EU, and Japan are adopting a de-risking strategy by realigning their supply chains and strengthening bilateral relations with their allies. 

We have identified countries such as South Korea, India, and Mexico as winners from this de-risking strategy. The list is by no means exhaustive, but we believe these markets are able to offer solutions to developed market manufacturers to diversify their supply chains.

Why now

At Franklin Templeton we cite three reasons why now is the right time for investing in emerging markets, what we call the three 'U's: emerging markets are under-owned, under-estimated and under-valued. 

Investor portfolio allocation to emerging markets are below that suggested by the index weight, they are under-owned. Investors are under-estimating the potential of companies in emerging markets, including those that could be at the forefront of the fourth industrial revolution.

The impact of these factors creates a significant opportunity as many of these companies are under-valued, or trading below their intrinsic worth from a valuation perspective.

Andrew Ness is a portfolio manager of Templeton Emerging Markets Investment Trust