After five years of disappointing returns, we believe we have approached the end of emerging markets underperformance. And the asset class looks cheap. In fact, some of the best growth stories anywhere in the world can be found in the emerging markets at what we consider to be reasonable prices, particularly compared to the stretched valuations in the developed world. We believe short-term thinking in a volatile asset class like emerging markets is nearly impossible, but the prospects for outperformance look strong over a three- to five-year period.
Unlike the previous bull market in emerging markets (2003-2007), which was very broad-based, we believe the way to invest in the emerging markets today is to selectively focus on high-quality companies that are positioned in tailwinds of growth. The previous growth period was driven by sustained fixed capital investment in China, accompanied by a global bull market in commodities and a credit boom in developed markets fueling global demand. Nearly everything in the emerging markets benefited as the rising tide lifted all boats and the MSCI Emerging Markets index returned an annualized 37% over that period. Unsurprisingly, passive investments and even high-beta benchmark-oriented active managers were able to do well in that environment. But we are in a dramatically different landscape today.
Growth all over the world is lower and harder to find. The implication for investors is that they need to consider selective approaches, less tied to an index like the MSCI Emerging Markets index, which is dominated by China, and within China the “old economy” sectors of financials, industrials and energy. These sectors reflect what was growing in the past decade. A benchmark-agnostic approach, on the other hand, creates the potential to capture future, rather than past, growth opportunities.
Our focus currently is on three main growth pockets in emerging markets: consumer, health care and financials. All three of these sectors are benefiting from rising incomes across the emerging markets and the shifts in behavior and spending patterns that accompany this trend.
Within the consumer sector, we have invested in companies that are leading the transformation from informal to formal retailing. Consumers are trading up to branded products and retail experiences such as eating outside of the home for the first time or developing a taste for Western-style snacks and confectionery. Another area we like is travel, where passenger traffic continues to increase year after year.
Within the health-care sector, we find opportunity among companies that are running hospitals or diagnostic services, as many countries seek private solutions to the provision of affordable health-care services for their growing populations. We have also invested in pharmacy retailers to capture the rapid growth in health care-related consumer products.