We discuss three key drivers of sustainable growth in emerging markets and the importance of strong corporate governance.
- Lower and middle-income countries represent over 80% of the global population, and an even higher proportion of those with young populations.
- We think it useful to break down sustainable long-term opportunities in emerging markets into three broad areas – Earth, wealth and health.
- When considering governance, we are ultimately trying to gauge the motivations and character of the people that ‘call the shots’ at any particular company.
- We believe it is probably ‘people’ and ‘culture’ that give the best insight into a company’s ability to navigate a changing landscape.
The emerging world often has institutions and capital structures that are less mature than those of their developed-world counterparts and, moreover, is often where we find the most underserved need for a wide range of goods and services that many in the developed world take for granted. As a result, we believe applying sustainable criteria when considering investing in emerging economies offers the opportunity not only to grow capital, but also to have a positive long-term societal impact.
Lower and middle-income countries represent over 80% of the global population, and an even higher proportion of those with young populations. The United Nations Conference on Trade and Development’s (UNCTAD) 2014 World Investment Report estimated that US$5-7 trillion of annual investment would be needed if we are to successfully attain the desired outcomes of the United Nations Sustainable Development Goals (SDGs) by 2030; it was estimated that roughly two-thirds of this expenditure would need to be deployed in developing countries.
Underserved and Underrepresented
Despite that, emerging markets represent little more than 10% of global equity indices, with the data consistently demonstrating that these markets are underserved and underrepresented. Their predicament highlights the significant opportunity to ride with the tailwinds around rising real incomes and urbanization, which are powerful structural growth stories in many emerging markets, as well as the chance to harness the adoption of technologies around clean energy, electrification, digitization and health care, to name a few.
In our view, there may be no more fertile ground for patient and sustainably deployed capital to have a positive effect on people’s lives, and to ultimately reward investors with attractive returns over the long term.
As mentioned above, there are a plethora of statistics that reveal the extraordinary level of underserved needs in the developing world which, as responsible investors, we think it key to address. Put simply, it is in the developing world where we most urgently need the deployment of large-scale solutions, and hence where companies whose products and services result in positive outcomes for the customer or society at large when consumed (or ‘solution providers’ as we call them) will find their most exciting growth opportunities.
For investors serious about investing responsibly in emerging markets for the long term, we think it useful to break down the opportunities into three broad areas – Earth, wealth and health – that we expect to drive much of the future growth potential in these regions. Below we assess each area.
The developing world offers the largest addressable market opportunity for environment-oriented solutions. These are the most populous regions of the world, where relatively faster rates of economic growth will increasingly draw on the world’s finite resources. Only around 25% of carbon emissions in 2020 were produced by MSCI World Index countries, compared to roughly 60% in the equivalent Emerging Markets Index countries, with most of the rest coming from Frontier Markets Index countries (economies which are less established than emerging markets).
China and India are currently the first and third-largest carbon emitters globally, and their CO2 per unit of nominal GDP in 2019 was three and four times larger than that of the US, respectively. Clearly, it is in the developing world where the biggest addressable market opportunity is for renewable energy and other clean technology solutions. It is also in the developing world where positive change is most urgently needed if we are to meet Paris Accord global-warming targets. China consumes roughly 1.7 times more electricity than the next largest consumer, the US. Hence, it is hardly surprising to see more renewable-energy installations in China than anywhere else. In the three years from 2018 to 2020, net new wind and solar photovoltaic capacity additions in China came to 240 gigawatts (GW), which is 43% of net global additions and 1.6 times those of the US, EU and UK combined.
Sadly, it is the case that child mortality rates in low-and middle-income countries are eight times higher than in high-income countries. It is a similar story if you look at maternal mortality, or child stunting, or a range of related statistics. There are opportunities for companies from different industries to play their part in addressing these depressing anomalies, ranging from pharmaceutical companies and contract research organizations, to hospitals and insurance companies. The growth runways can be huge for those companies that operate in countries where out-of-pocket health spending is very high, and where health spending per capita is low. In many emerging economies, populations are also ageing, and access to doctors, hospital beds, essential medicines and clean water and sanitation is woefully insufficient.
According to the International Finance Corporation, roughly 65 million companies, or 40% of global micro, small and medium enterprises (MSMEs) in developing countries, have insufficient access to appropriate financing, which equates to a US$5.2 trillion shortfall of credit every year. These MSMEs are key sources of formal employment in their respective economies. The World Bank estimates that they create seven out of ten jobs in emerging markets. Meanwhile, over one billion people globally are ‘unbanked’. There are vast opportunities for those companies that can responsibly bridge these gaps in credit and basic financial services. There are also significant opportunities for companies that can promote the development of productive infrastructure, whether related to transport, logistics or telecommunications, for example. It is estimated that emerging markets will invest an average of US$2.2 trillion annually on infrastructure between now and 2040, which equates to roughly two-thirds of all infrastructure investment globally.
The Importance of Corporate Governance
When seeking out suitable companies that can form part of the solution for some of the issues and trends described above, corporate governance is an extremely important consideration, as it should be in any investment decision. This is especially the case in emerging markets, however, where institutions are less mature, and where we see a higher level of listed-company control by the state and by promoter groups.
The key rationale for a deep consideration of corporate governance is well appreciated: to minimize the risks of value being inappropriately extracted from minority shareholders. At its crudest level, this can take the form of outright fraud, but it can also be more subtle, with more gradual or incremental value extraction. For example, it can occur through strategic priorities or mergers and acquisitions that are at odds with the long-term interests of minority shareholders. These risks can never be eliminated entirely, but an alignment of interests, and basic safeguards, can help emerging-markets investors to mitigate some of them.
No ‘Box-Ticking’ Exercise
When considering governance, we are ultimately trying to gauge the motivations and character of the people that ‘call the shots’ at any particular company, as well as the protections against them acting inappropriately. Our experience in emerging markets tells us that we cannot simply rely on a tick-box exercise around board structures and legal safeguards, although these considerations should not be overlooked. Deeper analysis and channel checking is required to establish whether promoters and management teams have a winning mentality and are appropriately incentivized to get positive results for all shareholders over the longer term. It is predominantly a qualitative, or investigative, process that helps us to understand whether we can trust controlling groups to look after minority investors, and other important stakeholders, through good times and tough times.
We tend to treat state-owned enterprises (SOEs) with caution, given the greater scope for conflicts of interest and lesser scope to appropriately incentivize management teams. We also have anxieties around certain types of promoter-controlled companies. However, we would not rule out making investments into either type of company. Some SOEs can become hubs of innovation, given their ability to attract talented scientists and engineers. And it is in promoter-controlled companies where you can find the best management mindset, with a deep focus on company durability and longer-term objectives. What is important in all instances is the alignment of interest, trustworthiness and a winning mentality.
Navigating a Period of Rapid Change
Many industries are changing at an unprecedented pace, and it is difficult to have any certainty about whether any given company is likely to be a consolidator, or disruption victim, when looking out five years or more into the future. This is well illustrated by the pace at which online platforms are now able to build up hundreds of millions of monthly active users within several years. But it covers all sorts of other potential game changers: solid-state electric-vehicle batteries, hydrogen fuel cells, nuclear-fusion energy, gene sequencing, and US-China relations, to name a few.
There are many inputs for this difficult question of whether a company is endowed with ‘moats’ to help it successfully navigate the future, with things such as brand strength, technology and intellectual property (IP), scale and networks being commonly referenced. However, it is probably ‘people’ and ‘culture’ that give the best insight into a company’s ability to navigate a changing landscape. When thinking about the long term, it is important to back intellectually engaged management teams with a growth mindset, who can allocate capital effectively; these are traits that can last more than one generation in some companies. These considerations also fall into the orbit of corporate governance.
It is our belief that those companies that can demonstrate a strong people culture, and which can proactively and genuinely strive to behave responsibly to reposition their activities to cater for large, underserved addressable markets based on their ‘needs’, will be the likely winners of the future.
 Source: Worldometers.info, 2021, Emission database for Global Atmospheric Research (EDGAR), CO2 Emissions, November 2019
 Source: International Energy Agency, 2021
 Source: World Bank, UN Inter-agency Group for Child Mortality Estimation, 2020
 Source: World Bank, 2020
 Source: Swiss Re Institute, 2020
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