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The COVID-19 pandemic has left indelible imprints on the world at large. Among others, the global crisis has exposed (and accelerated) macro-level divergences between emerging market (EM) countries, sectors, and companies. Varying health outcomes are of course one aspect of this, but it goes much further: COVID has magnified infrastructure gaps and ratcheted up environmental debates, while deepening geopolitical tensions and their impact on supply chains. To illustrate, we look at China as a case study.
What is the green transition?
As we have learned during our grassroots research trips, environmental concerns are an increasingly hot topic of discussion in EMs (albeit not to the same degree across countries) and are also becoming ingrained in the mindset of EM consumers, especially the younger cohorts. In large part, this is because pollution directly affects the quality of life and overall health of EM populations. In addition, climate deterioration has a meaningful impact on agricultural outcomes — a key sector for many EM economies.
Along with regulatory actions that may help spur change on the environmental front, the “green transition” (Figure 2) happening in the minds of consumers is reshaping their priorities and behavior and, in turn, driving investments and capturing incremental wallet share. For example, during our focus-group conversations within EMs, we have heard respondents talk passionately about a range of environmental issues, from a growing interest in new-energy vehicles in China to a willingness to pay premiums for environmentally conscious products in Brazil.
Infrastructure and the green transition
One broad avenue of EM investment opportunity that we have begun to pursue in earnest is what we call ” infrastructure and green transition.” Our latest research has focused largely on redefining what this opportunity set will look like in a post-COVID world, given the need to narrow infrastructure gaps between countries, increase rates of digitalization, and address environmental concerns.
In China, for example, geopolitical tensions (particularly with the US), the demographics of an aging population, and the need to push the economy to the next stage of advancement inform the framework for infrastructure development and related investable opportunities. In April 2020, the Chinese government unveiled a comprehensive new infrastructure plan (Figure 1) with three key areas of focus:
- Information infrastructure encompasses network infrastructure like 5G technology, ultrahigh-voltage transmission lines, charging equipment, the “internet of things” (IoT), industrial internet, artificial intelligence (AI), cloud computing, blockchain technology, and computing power infrastructure.
- Integration of infrastructure is the deep application of internet, big data, AI, and other technologies to transform traditional infrastructures. For example, so-called “smart city” construction is arguably vital to better urban management in the future.
- Innovation infrastructure refers to infrastructure with attributes that support scientific research, technology development, and product innovation. Recently, the government also announced a target of zero net emissions by 2060 — a massive commitment that will require significant infrastructure and technology development.
Investable themes and opportunities
Based on our understanding of the main goals of China’s new infrastructure plan and the current state of Chinese markets, we have identified the following thematic areas of investment opportunity (Figure 2):
- Building sustainable and productive communities
- Green transition
- Digitalization and local supply chains
After conducting meetings with numerous companies, particularly in the small-cap equity universe, we have identified some potentially attractive investable opportunities that appear poised to benefit from these trends.
Beyond China: Final thoughts
Across EM economies, fiscal stimulus packages delivered by governments have taken the driver’s seat in post-COVID support plans. If well thought out and executed, these stimuli have the potential to help narrow infrastructure gaps, address disparities in IT infrastructure, and tackle environmental challenges – all with the ultimate goal of propelling economic growth in the post-COVID period.
In addition, we assume persistent geopolitical tensions as a baseline for global dynamics going forward. We believe these tensions will continue to re-channel global investment flows, heighten the need for localization of supply chains, and perhaps facilitate the rise of domestic champions.
We believe all of this is creating attractive investment opportunities across EMs. The idiosyncratic domestic exposure of the EM small-cap space provides direct access to the burgeoning areas of opportunity that we believe will merit investors’ attention in the years to come.
- Capital risk
- Emerging market risk
- Common stock risk