By Erik Sherman
Investment categories are important to any investor. They help structure portfolios and enable rationale allocation strategies. Yet, categories can confuse over time, which is evident in the label of emerging Asian markets. What might seem like an expansive space is a numerically narrow one, albeit with enormous scale, opportunity — and contradiction.
“I’ve been doing emerging markets 25 plus years, and I still don’t know what an emerging market is,” says Kevin Ritter, a senior managing director, co-head of emerging market debt, and portfolio manager at PPM America. “Every index provider has a different definition and different approach to emerging markets.”
GlobalData, TS Lombard’s list of global emerging markets includes China, India, Taiwan, and South Korea in Asia. The other members, Brazil and Mexico, are thoroughly Western Hemisphere.
Notice the lack of Vietnam, Indonesia, or Singapore, which are considered frontier markets. According to Frontier Market News, although no set definition exists, frontier markets are more developed than a lesser developed country but more illiquid and less developed capital markets than in an emerging market.
MSCI’s Emerging Markets Index of 1,250 companies is 30.65% China, 19.08% Taiwan, 16.86% India, and 9.33% South Korea. The remaining parts are 4.24% Brazil and 19.84% other.
Even when a country is on the list, there can be confusion or even irony, as with China. “It’s also very strong and visible as the second largest economy globally,” says Claus Born, senior vice president and senior client portfolio manager, at Franklin Templeton Emerging Markets Equity. “But it has all the characteristics of an emerging market financially.”
“If you look at the income level, it’s a typical emerging market,” Born continues, noting a $12,000 per capita middle market income. “The second component of seeing if a country is an emerging market or developed market is the accessibility to foreigners.” For China, that access typically occurs through Hong Kong exchanges or even listings in the United States. “Overall, China is clearly an emerging market, but it conflicts with the image of China.”
Another aspect of China that might surprise is that companies there tend to focus on internal markets and not export. “Most of the revenue of Chinese companies, and I think it’s more than 85%, is generated in China,” Born says.
South Korea and Taiwan seem similar to many developed markets because of their economic development. However, issues of market access remain, according to Born. Until South Korea’s currency is traded outside of the country, 24-hour trades are impossible. And while stocks are “relatively cheap” compared to other markets, corporate governance “is not ideal.”
A well-understood attraction of emerging market equities is relatively low price-to-earnings ratios of 12 to 13 times rather than the low 20s of the U.S. “We are in a situation where we have good growth, in the high single digit to low teens and we have very low valuations,” Born says. “The risk is relatively low.”
Emerging markets are also more than equity trading. “From the debt holders perspective, emerging markets have been somewhat overlooked or a bit forgotten,” says PPM America’s Ritter. “The investment thesis for emerging market debt has stayed the same.” Many of the emerging market countries have made significant reforms in monetary policy, floating exchange rates, and fiscal policy.
“The broader investment community has forgotten these opportunities,” Ritter says. “You’re looking at yield or income pickups 50 to 100 basis points higher than US credit. Because they have been forgotten in some of the push for more yield in other sectors, it’s a spot [where] we find some opportunities.”
In some ways, the division of emerging markets into west and east is, excuse the wordplay, foreign to some Canadian pensions, according to Julie Caron, a senior vice president in institutional investment services at Franklin Templeton.
“We’ve seen a lot of interest,” Caron says. But how pensions treat emerging markets depends largely on the institutional size and resulting level of sophistication. “The smaller plans would do a GEM [global emerging market] allocation.” The bigger plans “will do an allocation to GEM but may do an India carve out or China carve out. There are debates if Korea should be included or not. If you remove Korea from the EM [emerging market] benchmark, it doesn’t leave you with much.”
In its 2024 annual report, CPP Investments said that it participates in “select emerging markets.” At the end of the fiscal year, the exposure to emerging markets was 20% of net assets compared to 22% at the end of 2023. “This decline follows the transition towards our revised long-term Strategic Portfolio emerging markets exposure target of 16%,” They wrote.
There also may be caution because of recent performance. “The MSCI Emerging Markets (EM) Index posted the weakest performance due to a contraction in China’s stock market since the pandemic,” wrote Caisse de dépôt et placement du Québec in an annual report.
However, Public Sector Pension Investment Board wrote that weak performance in developed market fixed income “was balanced by the decision to diversify into emerging market debt which had strong performance of 8.3% over the period.”
Reminding big investors that one institution’s emerging is another one’s emerged.
