In emerging markets, investors often think about geopolitical risks. But, according to Andrew Stobart, investment manager in emerging markets equities at Baillie Gifford, democracy is not a prerequisite for growth in emerging markets and there are other, more important factors that have driven investment returns.
Despite numerous economic and political crises since the late 1980s, emerging markets are still an attractive destination for investors, Stobart explained. During his presentation at the 2016 Global Investment Conference, held in San Diego from April 6-8, he highlighted numerous crises in emerging markets since 1988 including the 1991 dissolution of the U.S.S.R., the 1994 Mexican Crisis and the 1997 Asian Crisis just to name a few. However, when comparing the MSCI emerging market equity index since its inception in 1988 with the S&P/TSX Canadian Index or the MSCI developed world index, emerging markets have significantly outperformed, despite these numerous periods of turmoil.
Looking past these crises, Stobart noted that the key drivers of success in emerging market economies can be attributed to: success in manufacturing exports, improvements in property rights and the health of balance sheets at the country level. Many of these are heavily influenced by geopolitics.
“As an economy, if you want to grow quickly, you have to export,” Stobart said. “And to expand fast sustainably you need to export manufacturing goods. This creates employment, enables development and crucially generates foreign exchange.” He also said that this exposes an economy to global market standards.
Stobart said success in manufacturing exports relates to the luck of geography and also to political policies that support export industries. The countries successful in exporting manufacturing goods in the 1990s and 2000s were either next to big developed economies or on the same shipping lanes as Japan and the original Asian tigers.
Stobart outlined how property rights are also critical for domestic growth. Politics plays a role here too and he explained that when ex-Marxist states established market-oriented property rights for the first time, this in turn enabled private credit to expand rapidly and consumption to boom. According to the Fraser Institute’s freedom index, during the 2000s many of the most successful emerging economies in terms of per capita GDP growth were former communist countries.
Stobart said that balance sheet stress at the whole economy level is also a significant factor in spotting opportunities in emerging markets. In the 1980s, there was a plethora of sovereign defaults and hyperinflation across much of Africa and Latin America. Many governments allowed excesses to spiral. After this period, many governments began reforming their economies, which allowed emerging markets, from healthier starting points, to grow in the 2000s.
While geopolitical risk is a concern for investors, Stobart said that when it comes to emerging markets, the economic system is more important than the political system. “It’s not the right to vote that matters, but whether the country is open for business,” Stobart said. “It’s not about democracy, it’s about capitalism.” China is arguably the best example of this, a country which remains communist but which has embraced capitalism.
It is crucial to take account of geopolitics when investing in emerging markets. The experiences of the last three decades shows that there are some key factors to monitor (manufacturing exports, macro level balance sheets and political change) while there is also a lot of ‘noise’ which can be ignored.