Magazine issues » July 2021

Talking heads: Committing long-term capital to emerging markets

Terraced_fields_VietnamIndustry experts offer in-depth analysis of the emerging markets landscape, including the main challenges ahead and which areas to watch out for.
The best thing investors can do is reduce the risk perception of emerging markets (EMs) and they can demonstrate this by committing long-term capital to EMs. We know that institutional capital leads to the adoption of ESG standards, but this must be done at scale. The Development Finance Institutions have done a lot of groundbreaking work to educate and establish standards but capital from the large asset owners is now needed to meaningfully scale the opportunity. We live in an interconnected world and even non-EM investors are exposed to ESG risk in EMs through supply chains and subsidiary revenue streams. ESG risk can be disruptive and have long-term impacts on business operations, reputation and valuation. Beyond ESG risk, investors should look to EMs for investing in business models that deliver social and/or environmental impact and commercial returns at scale. Take renewable energy for example, returns from utility-scale solar projects in the developed markets, for the most part, don’t really offer compelling private equity style returns. In many EMs, however, the cost of energy and the lack of infrastructure mean that renewable energy presents a strong business model: a source of significant savings and reliability to the users and from the investor’s perspective, can be underwritten to strong private equity upside. We have invested directly in the commercial and industrial (C&I) sector in Nigeria and in an SME financier in India to help roll out solar rooftops. In both cases the impact is reduced reliance on diesel generators and significant energy bill savings. What opportunities has the pandemic created in emerging markets?
Two obvious areas are in telemedicine and digital education, which had been growing sectors even prior to the pandemic but have become the focal point of much investment activity. While this is dependent on the quality of digital infrastructure, the ubiquitousness of cellphone data services has led to modified formats that can extend the reach of healthcare and education beyond the main population centres. The pandemic has also drawn focus on the food supply chain and led to innovative business models focused on streamlining access to fresh produce, staples and meals as work and consumption patterns have changed. Which have been the hardest-hit areas in EMs, and what is your outlook for the rest of the year?
Sectors that relied on footfall, such as domestic consumer or foreign tourists, have been very hard hit. However, most emerging markets companies have a degree of resilience from decades of dealing with disruption from economic and political crises and even previous pandemics – Sars, bird flu etc. But the impacts of Covid-19 have been of a different scale and while many investments have recovered to pre-pandemic level of operations, we haven’t seen the end of the effects of the pandemic yet. Our view is that the scope for climate investments in areas like renewable energy, water efficiency, sustainable agriculture and recycled building materials is strongly supported by structural trends in EM and will be necessary to deal with the pressing climate threats to these countries after Covid-19 has passed. We believe there will also be a major policy rethink in many EM in three areas:
  1. Reliance on tourism
  2. Healthcare access; and
  3. Financial security for the most vulnerable workers.
In that last category, for example, there’s a strong overlap between climate vulnerability (farm workers who have to live with crop failure or extreme weather) and sensitivity to footfall (such as taxi drivers or cafe workers) with an increased access to insurance and micro insurance as part of the solution set.
Marshall_StockerMARSHALL STOCKER, DIRECTOR OF COUNTRY RESEARCH, EATON VANCE Have recent Covid developments, particularly in India, impacted the investment outlook for emerging markets?
No. Recent developments do not represent a collectively negative impact for emerging markets. Of course, India’s near-term economic growth is being negatively impacted by a massive Covid conflagration. For one, manufacturers such as Foxconn disclosed that iPhone production in India has been halved due to employee illnesses. Demonstrating the idiosyncratic nature of the pandemic, Uruguay recently had the highest per capita daily Covid death rate despite having a relatively higher vaccination rate among emerging markets. Yet, across emerging markets mobility and economic output is collectively recovering strongly, above expectations. For each of the 100-plus emerging market countries we research, Eaton Vance is carefully monitoring a country’s access to a supply of vaccines, the timeline to ‘full’ vaccination, and the institutional capability to manage and prevent infection conflagrations in the interim. Certainly, the country’s financial resources to address primary and secondary effects from the supply-side constraints that a pandemic imposes is a critical input when we determine the outlook for an emerging market country. Altogether, the investment outlook remains bright for many emerging markets which have achieved impressive vaccination rates, like Chile, Cyprus, Greece, Iceland, Serbia and the UAE, or demonstrated the institutional capacity and financial resources to address the short-term disruptions of the pandemic. A controlled pandemic has meant the continuation of economic reforms, increases in economic freedom – making emerging markets attractive for investors. Emerging markets are said to be improving on ESG criteria. What issues do analysts currently face with data standardisation, and what are they doing to overcome it?
Data standardisation problems in emerging markets cover a wide range of matters: ESG, financial, and economic data. This presents a rich opportunity for investors to identify countries and investments where data transparency is improving, often from a low base. We conduct sovereign-level engagements to champion improvements in data transparency and standardisation. This active investment management effort is supported by our empirical research which demonstrates improving data transparency lowers the discount rate on assets. To overcome the lack of data standardisation and transparency, we utilise alternative data sources, painting them into a mosaic which allows us to make a conclusion about not only the level of ESG conditions in a country, but more importantly, forecast the direction of change. Which emerging market countries are the ones to watch out for over the coming year, and which ones are most challenged?
We identify countries where we believe the policy environment will improve, causing an investment’s cash flows to increase, the discount rate to fall, or both. We believe that Egypt will build on recent policy improvements with continued reform momentum. Romania and Uzbekistan may also execute reforms that benefit investors. Indonesia’s recent omnibus bill improves the business environment and should similarly lead to attractive investment returns over the coming year. We would exercise caution with countries that are not undertaking reforms to improve their economic institutions or, worse, likely to implement policies that will negatively impact the economic institutions which underpin a country’s economy. More specifically, countries which are likely to decrease economic freedom or where ESG conditions may deteriorate during the investment horizon be the most challenged to deliver attractive returns to investors.

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