Emerging market investors have been battered by a decade of lackluster growth and uninspiring absolute returns. Now, as the trauma of Covid segues into the tragedy of war, we understand the temptation to fall back on linear extrapolation. But this would be a mistake: we contend that there is a lot for global emerging markets (EM) investors to be excited about. 

This Time Is Different
Let’s begin by addressing the market’s current obsession with rising inflation and interest rates, and the perception that this must be a disastrous thing for EM. It’s a seductive theory; after all, every EM crisis in the last 40 years has been associated with a rising federal funds rate, a dramatic tightening of liquidity and massive capital outflows. On the other hand, there have been just as many occasions—the early 1970s, or the early 2000s, for example—when rising U.S. interest rates caused barely a ripple in EM.

Today’s reality is that many of the beneficiaries of inflation are in EM, including the energy and commodity producers, which have seen a marked upswing in fortunes this year. On the rates front, countries such as Brazil and Mexico pre-emptively increased interest rates long before their western counterparts, so have more room to maneuver. Similarly, China still has the luxury of positive real interest rates, allowing them to ease rather than tighten as growth slows.

Fine, but what about the golden age of globalization coming to an end? The verdict of many commentators is that EM—as the biggest prior beneficiaries of globalization—will be those most challenged by its reversal. This is a dangerous oversimplification, not to mention inconsistent with the arc of human progress. 

Supply chains will continue to evolve, but there are still likely to be plenty of winners in EM even amid a reshuffling based on geographic and perhaps also political contiguity. Meanwhile, the largest economies will continue to look inward for growth. Self-sufficiency, billion-plus home markets, and growing evidence that homegrown companies can capture demand previously exploited by multinationals listed elsewhere will continue to provide stock-pickers with long-duration growth opportunities.

Net Zero: The New World Order
The energy transition is one area we are thinking hard about in the context of long-duration growth opportunities. We have been sympathetic to the arguments for upside surprises in the prices of several important commodities in recent years. What interests us far more than this, however, is the likelihood of an acceleration in the energy security and renewable agenda.

If we are to stand a chance of meeting this agenda, we will need a lot of stuff. Wind turbines, solar arrays, energy storage, electric vehicles and all of the associated infrastructure will not only require lots of steel and concrete, they will also require huge amounts of specialty metals and minerals such as lithium, copper, graphite, nickel, chromium and neodymium. And where are the largest, lowest-cost, most efficient and highest quality producers of this stuff? They are mostly in EM.

The energy transition may be as important an investment theme in the coming decades as Moore’s Law—the principle that computing processing power doubles every two years—has been in previous decades. What is striking is just how many of these beneficiaries are in EM—from the commodity producers and infrastructure providers that will build the new age, to the semiconductor companies, energy solutions providers and platforms that will power it. 

Hitting The Demographic Sweet Spot
On a more macroeconomic level, advisors and investors should consider the demographics and dependency ratios in different countries. In countries where there is a high number of children or pensioners per adult of working age, savings tend to be minimal, capital is expensive relative to labor, and interest rates tend to be high, while investment tends to be low. 

The higher the ratio of working adults to dependents, the better the banking system is equipped to fund investment needs. After all, a dependency ratio north of two is the sweet spot that North Asian economies, such as South Korea, have been in since the 1980s. It is exactly this sweet spot that many of the larger commodity economies in EM, such as Brazil or Indonesia, have only entered more recently. 

Brazilian GDP per capita has halved in U.S. dollar terms over the last decade, and we suspect that this “lost decade” might be clawed back sooner than anyone expects. The demographic sweet spot should certainly be helpful for Brazil—the ratio of adults per dependent moved above two in 2010 and will remain there until at least 2040 and at 80% of GDP versus 40% in the early 2000s, deposits are now big enough to finance growth. If we add in the potential for an improved commodity cycle to stoke the virtuous cycle of a stronger currency, lower inflation and lower real rates, and consider the possibility that human capital is now ready for an ICT revolution—the impact on growth could be profound. 

It’s Not Just China
The potential economic resurgence of countries such as Brazil is important, but it’s symptomatic of a far more exciting trend: the emergence of new and innovative companies in parts of the world that have historically not been known for their corporate dynamism. This is the big story that no one is paying nearly enough attention to, yet it’s the one that matters most for the longer-term health of the asset class.

China is no longer the only game in town. Indeed, one of the most encouraging developments over the last year or two is the variety of interesting and differentiated businesses from India, Brazil, Indonesia and beyond.

There are some commonalities: the arrival of 5G and the cloud appear to finally be democratizing entrepreneurialism in many of these countries, as has already been the case in developed markets and China. It is unlikely to be a coincidence that one of the most remarkable transformations appears to be underway in India, a country that in the space of five years went from having one of the worst mobile internet infrastructures in the world to one of the best, and now also boasts the largest and fastest-growing open digital payments infrastructure in the world: last year India produced more unicorns—privately-held start-up firms valued at more than $1bn—than anywhere else in the world apart from the U.S. and China (and based on the numbers so far this year, the country has leapfrogged China into second place). 

Conclusions
The lesson of history is that individual dislocations associated with war and pandemics can take years to normalize; we have now had both in rapid succession. As markets continue to oscillate wildly in response to every shift in the yield curve and inflation expectations, volatility will remain the only constant. However, we retain our optimism that the 2020s will be a much better decade for emerging market investors than the 2010s.

Will Sutcliffe is head of the emerging markets team at Baillie Gifford.