Double-digit inflation, political uncertainty, currency volatility, increasing costs of borrowing, and economic stagnation; UK investors are learning more about this state of affairs every day. Yet, for emerging market investors, these circumstances are all too familiar.
This year has been another of volatility in emerging markets following a divisive election in Brazil, higher debt repayments as the US dollar strengthens, depleting foreign currency reserves and the continuing threat of inflation around the world. In turn, emerging market stocks have experienced a rough ride with the MSCI Emerging Market Index down by nearly a third year-to-date.
Amid the recent market rout, the lesson for investors is clear: emerging markets stock pickers should seek out resilient firms and stewards with defensive financial profiles to ride out this latest storm.
Why resilience is key across emerging markets
It is easy to get lost in the weeds when looking at EM economies and companies. To the untrained eye, political risk, currency volatility, and high sovereign debt resemble an unappetising cocktail with the potential to leave investors regretful. However, for many firms operating in emerging market economies, the reality is this latest crisis is unlikely to cut as deep as previous events.
Just take Brazil, in the past 30 years it has experienced a number of divisive and destabilising elections, hyperinflation, and fears around military coups. Yet, during this, a number of high-quality companies and resilient stewards have emerged and ultimately thrived in spite of these crises.
For example, Brazilian company WEG was founded in 1961 by three co-founders Werner Ricardo Voigt, Eggon Joao da Silva and Geraldo Werninghaus. Whilst the company has evolved over the decades, from a manufacturer of electric motors in the 1960s to a leader in renewable energy solutions, the business remains majority-owned by the founding families and has grown to be active across global markets.
Firms, like WEG, which combine patient family-owned stewardship with industry-leading expertise, are well-prepared for instability and know how to weather market and economic turbulence.
Finding quality in emerging market firms
Finding quality and value in emerging market firms also means identifying those companies that blend long-term financial returns with social value and stewardship.
Climate change is becoming a reality of day-to-day life in emerging markets, so investing in those companies that form part of the solution goes hand-in-hand with future-proofing an emerging market investment portfolio.
Positively, a number of forward-thinking and innovative companies across EM economies are contributing solutions to environmental issues, and thus are benefiting from growth derived from the shift to a more sustainable development path.
WEG is one such firm and has been able to develop into a global expert in renewable electricity generation infrastructure and now derives more than half its sales from overseas. Its equipment will help the rest of the world’s energy mix become greener and support the global energy transition to become a reality. Companies, like WEG, are likely to continue to provide attractive long-term returns over time as they benefit from these sustainable tailwinds.
When looking for resilient firms, it would be wrong to ignore the impact that global and market events have on emerging marelt stocks. Yet, we are seeing that quality firms in the region are also more prepared now than previous periods of market turmoil.
Balance sheets have strengthened in recent years, in contrast to the Fed ‘taper tantrum’ years, and quality firms have also been able to better manage their currency risk. For example, WEG earns revenue in dollars and pays out in local currencies, offering some cover for swings in FX. There is also growing optimism for the years ahead with EM stocks returning to pre-pandemic multiples and valuations looking increasingly attractive to potential investors.
Conclusion
For bottom-up stock pickers, identifying competent stewards who manage growing, resilient franchises with defensive financial profiles continues to be the best route to deliver sound absolute returns over the long term. Furthermore, sensible diversification and avoiding economies with particularly high economic and political risks counterbalance some of the inherent risks when investing in such countries. Don’t underestimate emerging markets’ ability to bounce back from this period of instability, they are more resilient than you think.
Jack Nelson is a portfolio manager at Stewart Investors. The views expressed above should not be taken as investment advice.