Commentary: Understanding the growth opportunity for today's top emerging market companies

Institutional investors in today's emerging markets face a host of risks, ranging from rising trade tensions to cyclical challenges stemming from the prospect of any slowdown in global economic growth. Against this difficult backdrop, however, a number of powerful fundamental trends — from favorable demographics, rapid technological innovation and progressive economic reform — are converging to create a potent set of dynamics that could continue to define medium-term opportunities within emerging markets equities. An understanding of these trends is critical in identifying those companies that we believe may succeed in becoming tomorrow's domestically grown stars across emerging markets broadly.

The broader context of demographic trends in emerging markets is well known. The most powerful among them is the growth of middle-class and related consumer disposable income, with the 12 largest emerging economies expected to account for as much as 33% of global consumer spending by 2030. Understanding the nuances of these trends as they evolve is vital in anticipating how they may influence the underlying investment case for individual companies.

For example, it's widely understood that China is an aging society. Less well recognized is the significant size both of its millennial population and female labor market participation, all contributing to shrinking household size. These characteristics result in incremental spending power — both in the hands of empty nesters as their one child grows up and of a generation of young affluent adults.

China's consumption patterns are evolving most rapidly among the generations born after 1980. Just as members of the post-war baby boom generation in the United States and Europe powered economic activity as they entered their prime earning years, today's younger generations will drive consumption patterns in China and elsewhere in emerging markets.

As these demographics play out and reshape patterns of consumer behavior, it's important for investors to understand the defining characteristics of the businesses — which may be domestic, regional or multinational — that appear most likely to compete successfully. Leading emerging market regional companies as well as multinational corporations are naturally attracted by the large scale of emerging market growth opportunities, but face challenges from locally established names, which may enjoy an edge in terms of domestic distribution networks, brand recognition and on-the-ground knowledge of their domestic markets — advantages that may create effective barriers to entry.

By way of illustration, sportswear giants Nike and Adidas compete with dominant domestic brands such as Anta and Li-Ning in China, with the latter exploiting the advantage of the company's knowledge of local consumer preferences and an extensive distribution network.

Asia has long been the manufacturing base for the world's high-tech equipment, with smartphones and other electronic devices relying on a complex supply chain that spans China, South Korea and Taiwan. Importantly, ongoing investment in research and development has generated significant intellectual property, which is enabling companies involved to capture an increasing share of overall value.

Asia's rise up the technology curve is also reflected in key patents for next-generation 5G wireless technology, which holds the promise of radically changing how people, businesses and devices connect. Chinese companies had applied for 34% of the world's major 5G patents as of March, compared with South Korea's 25% and 14% each for the United States and Finland. Compared to 4G standards, China and South Korea have notably improved their positions, while the United States and Japan have fallen behind.

These patent positions give Asian companies a seat at the table to decide 5G standards, putting them in prime position to benefit as 5G begins to be rolled out across a range of applications. Initially, 5G will offer much faster smartphone speeds and a cost-effective alternative to fiber broadband in some rural areas. In the more distant future, 5G may be adopted for machine-to-machine communications such as automotive applications, where cars will connect to other vehicles and allow better traffic control. 5G is also expected to be used in the internet of things to connect machines on smart factory floors and transmit data to the cloud for analysis. An embodiment of this trend is MediaTek, a Taiwanese company that was late with 3G/4G smartphone baseband chips but has significantly closed the technology gap with market leader Qualcomm and is in a better position as 5G is implemented.

Innovation has powered the financial services sector across the developed world for many years and is now rapidly gaining traction across emerging markets. The ability to process information seamlessly is reducing administrative costs, and specialist services and products that were previously available only to a limited number of customers through narrow distribution channels are becoming commonplace and widely accessible. Financial inclusion of segments of society that previously had little access to banking and other financial services has become a powerful economic and social phenomenon.

The example of Network International illustrates the potential. The relatively young United Arab Emirates-based company has grown over the past 20 years into the leading enabler of digital commerce across the Middle East and Africa, which remains the world's most underpenetrated payments market. Digital payments technology is established both in developed markets and faster-growing economies, providing a blueprint for the untapped Middle East and Africa region, where Network International is the only pan-regional provider of payment solutions with scale across the entire payments value chain.

The intersection of demographics, technological innovation and economic reform has created a mosaic of constantly shifting considerations for emerging markets investors. Ultimately, it is crucial for investors to think about structural trends in tandem with local nuances to assess opportunities. Investors will be best served to avoid painting emerging markets with a broad brush to find the companies with the most promise for growth.

Kathryn Langridge and Philip Ehrmann are senior portfolio managers at Manulife Investment Management, London. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.