Manraj Sekhon, CFA
Chief Investment Officer,
Franklin Templeton Emerging Markets Equity

Sukumar Rajah
Senior Managing Director, 
Director of Portfolio Management,
Franklin Templeton Emerging Markets Equity

Chetan Sehgal, CFA
Senior Managing Director, 
Director of Portfolio Management,
Franklin Templeton Emerging Markets Equity

We see an undeniable change in the long-term narrative for the entire asset class taking place, driven by the pursuit of a better life. Yet, outdated perceptions about EMs persist. Franklin Templeton Emerging Market Equity casts a light on new growth drivers in EMs, and what it means for investors.

New Drivers of Growth in Emerging Markets

Key Takeaways:

  • EM economies have diversified, with consumption and technology offering new drivers of growth
  • EMs are leapfrogging established models in innovation and technology
  • However, progress across different countries in uneven, requiring a selective approach to identify

Outdated Views

A simple roadmap guided most EMs looking for growth some 20 to 30 years ago—produce and sell abroad. Countries with abundant reserves of oil, precious metals or other commodities shipped them to resource-hungry industrialized nations. Other economies tapped large pools of affordable labor to become cheap manufacturing hubs for the West. Unsurprisingly, the fortunes of these EMs often shifted with the rest of the world’s.

The echoes of this past remain strong. Many investors continue to view EMs as cheap exporters reliant on DMs for growth and are uneasy about the perceived cyclicality of EM investing.

While a public narrative focused on EM’s economic exposure to developed markets continues to make headlines, it neglects to recognize that EM economies have evolved dramatically as they have moved up the development ladder. In some of the largest EMs, such as China, we are seeing the rapid rise of homegrown economic drivers—consumption and technology—overshadow old industries linked to commodities or low-cost exports. Rapidly rising domestic consumption within large economies such as China has, in turn, resulted in a greater share of intra-EM economic exposure relative to developed markets.

Changes in the MSCI EM Index illustrate the shifting economic landscape. In the past ten years, energy has nearly halved its weighting in the MSCI EM index from 15% to 8%; the materials sector has also shrunk. However, technology’s weighting has more than doubled from 11% to 27%, and the consumer discretionary sector has also grown.

Penetration and Premiumisation

Consumption has played a significant role in propelling emerging economies. A growing middle class, confident in its newfound wealth and outlook, has been spending more on goods and services at home. Companies ranging from retailers to banks have seen market penetration increase. Beyond this trend lies another known as “premiumisation”. As incomes continue to rise, demand for higher-quality goods and lifestyle experiences has picked up. Altogether, EM consumption looks set to climb further and exceed that in DMs by a wide margin.

New Drivers of Growth in Emerging Markets

Climbing the Technology Curve

Then there is technology. EMs that achieved initial success as producers of cheap home appliances or electronic parts have set their sights further up the value chain. Indeed, with China (and Korea) as a leading example, the EM share of global high value-add exports has risen dramatically since the start of the twenty-first century rendering this impression out of step with reality.

Global Innovators

As a common fallacy goes, the past predicts the future. And so many investors expect EMs to track DMs’ development path. By extension, as DMs move up the technology curve, EMs should naturally follow behind.

We disagree. Several EMs have seized the lead in innovation and are leapfrogging the West in areas such as e-commerce, digital payment, mobile banking and electric vehicles. As a broad indication of EMs’ collective advance, they have overtaken the US and Japan in terms of patent applications. Robotics patent applications in China alone are running at more than double the rate across all DMs.

Coupled with the inflection in patent applications, we also see a long runway of growth for the semiconductor industry amid rapid developments in areas such as the Internet of Things, artificial intelligence, and autonomous driving with direct implications for EM company prospects. For instance, South Korea and Taiwan already stand tall as two of the world’s largest semiconductor manufacturers today. South Korea-based Samsung Electronics, which made its mark producing televisions in the 1970s, has gained global dominance in memory chips. Meanwhile, some of the most sophisticated chips powering a host of devices such as smartphones and servers come from Taiwan Semiconductor Manufacturing Company (TSMC). This is a company with an exceptional track record in first developing and then extending an intellectual property lead over established U.S. competitors such as United Foundries and Intel.

In some ways, EMs’ weaknesses have become their strengths. Unhindered by sunk investments in legacy systems or infrastructure, they have had ample room to come up with creative solutions for some of their biggest challenges.

Navigating Opportunities Selectively

The age-old desire for progress is a powerful force and, in this regard, innovation has an important part to play. We expect EM governments to continue promoting sound policies that promote higher incomes and a better quality of life for its people. Nonetheless, technological progress is uneven across EMs and we believe that investment landscape remains a complex one that requires an active stock-picking approach. We foresee stronger companies pulling ahead, resulting in a greater dispersion in stock returns. We expect the most compelling long-term returns from companies with sustainable earnings power, trading at discounts to their intrinsic worth. And experience has shown us that solid fundamental research will be needed to identify them.

The comments, opinions and analyses expressed herein are solely the views of the author(s), are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

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