Kepler & Partners’ David Kimberley: Emerging market shifts

China’s economic growth has dominated the EM story of the past two decades.

That arguably reached its zenith in October 2020, when the country’s weighting in the MSCI Emerging Markets Index peaked at close to 45%.

But as that ‘peaked’ suggests, the past three years have seen sentiment towards Chinese equities change dramatically.

TEMIT’s Chetan Sehgal: China singles day is changing

Clampdowns on tech firms and other sectors, such as private education, have unnerved investors, as have frictions with the US and serious problems in the property sector.

Today China’s weighting in that same index is below 30%.

China is also a very different place to two decades ago. Per capita income is on par with the poorer EU member states. The country has aged.

At the start of the millennium, the median age was 28 years old. By 2025 it is forecast to be 40. Like Japan, China’s population is also starting to decline.

Does that mean it is all over for investors in China? No. For one thing, the negative sentiment we have seen over the past few years has driven valuations to more attractive levels.

Alibaba, for example, is now trading at the same price it was at in 2016 – which may explain why it is now a major holding in the portfolios of Fidelity Emerging Markets (FEML) and Invesco Asia Trust (IAT).

Barings’ Ricardo Adrogue: The implications of the global trade realignment are underway

Alibaba is also illustrative of the fact that investing in China is not just a play on a massive capex boom. Instead, opportunities are more likely to be driven by technology companies or consumer goods.

Given China’s vast population, companies in both sectors can see significant growth without the sort of GDP growth it has delivered since the turn of the century.

China’s increasing wealth, as well as tensions with the US, also mean that we are seeing a shifting of manufacturing to other countries in Asia.

Two of the big ‘winners’ in this regard are Vietnam and India.

The former signed a ‘Memorandum of Cooperation’ with the US earlier this month, which should serve to boost semiconductor manufacturing in the country.

Apple and Samsung already have substantial manufacturing capacity in Vietnam, with over 60% of the South Korean firm’s smartphones now produced there.

Can China still hit its 2023 growth targets?

Vietnam is also enjoying the same sort of growth trends that China has seen. For example, infrastructure investment is forecast to hit $30bn annually from 2022 to 2025.

Over the same period, the country is set to see annualised growth in urbanisation of 2.7%, one of the highest rates in the world. Today, the population is only 38% urbanised, compared to over 60% in China.

This room for growth is the reason why urbanisation is a key theme in the Vietnam Enterprise Investments (VEIL) portfolio.

India is going through a similar process, with an increasing number of multinationals keen to move manufacturing to the country and the Modi government announcing a new ‘Made in India’ policy designed to boost manufacturing last year.

For example, iPhone manufacturing is now taking place in the country, and Boeing recently announced that its largest facility outside of the US will be in India.

Deep Dive: A rising middle class is key to ‘good growth’

Latin America is also benefiting from these shifts but in a different way. Mexico saw a 15-17% increase in imports from China in 2021 and 2022.

Interestingly, it saw equivalent upticks in exports to the US in both years.

Either you believe in coincidences, or Chinese firms are shifting imports to Mexico, most likely to avoid tariffs and reduce the likelihood they will be hit by any trade restrictions in the future.

There have been some concerns that Latin American countries will suffer from the end of China’s capex boom.

That may be the case, but there are signs this will be offset in two other key ways.

One is that we are seeing a huge ramp up in demand for the raw materials needed to make the much-vaunted shift to a carbon neutral world.

The other is that the shifts in supply chains and urbanisation we are seeing in places like Vietnam may drive the same sort of demand that China produced previously.

Both trends may benefit BlackRock Latin America (BRLA), which has exposure to copper and other commodities producers in the region.

Number of managers with global emerging markets ex-China strategies rises fifteenfold in six years

Whatever does ultimately take place, for investors in emerging markets it means something of a rethink.

Investing in China today is more about looking for consumer growth stories or higher end tech firms, rather than trying to reap the benefits of a capex boom.

That shift, along with rising tensions with the US, are having knock on effects that will mean more opportunities for investors in places, like China or Vietnam, which may be better accessed via country specialist funds.

Meanwhile, countries in Latin America are shaping up to enjoy both surging demand for commodities, as well as the ability to act as neutral parties in the US – China standoff. We live in interesting times.

David Kimberley is an investment trusts writer at Kepler & Partners