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In this interview, Dáire Dunne outlines his thoughts on the importance of economic development in emerging markets (EMs), the investment opportunities it creates and the impact of COVID-19 on this secular trend.
Q. How does economic development differ from economic growth?
Economic growth is about increases in gross domestic product, which is a quantitative measure of the size of an economy. It measures the quantity of economic change over time.
Economic development is concerned with the quality and durability of this change. It relates to increasing the productive capacity of an economy, making responsible use of available resources, promoting economic inclusivity and engendering a better quality of life for citizens. Development puts in place the foundations on which long-term, high-quality economic progress can be achieved.
Q. Why does economic development matter?
Our research shows that economic development is consistently associated with more stable economic progress and inflation paths across countries and over time. The importance of macro stability in EMs cannot be overstated. Those countries with the highest level of macro stability generally have easier and cheaper access to international capital markets — an enormous advantage when making long-term, productivity-enhancing investment decisions. An additional consequence of development progress is political stability. Governments that improve the social, economic and environmental contract they have with their citizens tend also to command more enduring popular support and build clear political legitimacy.
Q. Does economic development impact financial markets?
We see clear linkages between development and financial markets. Development helps establish positive feedback loops between the public and private sectors, fostering political transparency and stability, as well as entrepreneurship. These are all essential ingredients for long-term economic progress. Markets, as well as credit agencies and lenders, consider these variables in their assessment of risk premia.
There is also evidence that countries with an economic development focus are more likely to enter self-perpetuating cycles of productivity and innovation. In addition to generating lasting improvements in living standards and social mobility, this economic development focus creates attractive opportunities for investors related to local policy and domestic demand. Our research highlights the fact that those parts of the emerging world that have made the most development progress also have established the broadest and most liquid equity markets and most profitable corporates, as measured by average returns on equity.
HOW HAS THE PANDEMIC IMPACTED EMS’ LONG-TERM ECONOMIC DEVELOPMENT TRENDS?
In our view, the COVID-19 crisis has shortened investor time horizons and driven significant discounting of the future. For allocators willing to look beyond this period of disruption, we believe EM equities present attractive opportunities. We think emerging markets are likely to become fertile hunting grounds for stock pickers as the world stabilises, given their enviable demographics, opportunities for continued productivity-driven growth and less efficient capital markets. Thematically, we would highlight several enduring and attractive opportunities, such as China’s economic transformation and the globalisation of its capital markets, the regionalisation of global supply chains and the continued innovation and disruption driven by technological innovation across industries. Ultimately, we believe these opportunities are best captured by analysing how developing countries are likely to evolve over the next 5 – 10 years and then focusing capital on the key areas of secular growth.
Importantly, key risks remain related to the COVID-19 crisis including significant uncertainty regarding both the human and economic damage that will be caused by the virus. Within EMs, there are also valid concerns surrounding the adequacy of health care systems within many countries. Amid the volatility caused by the coronavirus outbreak, the current market environment has proven to be an interesting time to look at relative-value trades across EMs. The coronavirus outbreak has led to the acceleration of some of the structural transformations identified within the themes, such as the increased importance of digital connectivity during the recent global containment measures.
While we should expect economic data in EMs to have a meaningful period of weakness as weaker health care systems and safety nets are stressed by the COVID-19 outbreak, we do not currently see any signs that would represent a threat to the long-term structural themes driving economic development.
Q. Where do you believe economic development is most visible in EMs today?
Across Asia, there is now widespread commitment to infrastructure investment, from the Build, Build, Build programme in the Philippines, to improvements in inter-island connectivity in Indonesia, to the Eastern and Western Dedicated Freight Corridors in India.
Recent Chinese five-year plans feature an increased focus on education (world-class universities scheme) and on health care (Health Action Plan). India’s academies for the poor, China’s education startups, Indonesia’s empowering credit entities and Kenya’s mobile payments advances also speak to the educational and financial aspirations of many across EMs.
We believe COVID-19 has also reinforced the need for increased spending on health care infrastructure globally. EM countries which have prioritised investment in hospitals, clinics, medical testing and research have been better equipped to cope with the global pandemic. In addition, investments in digital infrastructure are particularly relevant in today’s crisis. As working from home and virtual education are drastically growing, there has been considerable strain on digital infrastructure. This has highlighted the value of development in this space.
Q. What are the benefits of using a development lens in EM investing?
Investments that either enable or benefit from economic development are disproportionately local in orientation, idiosyncratic in their risk profile and capable of generating high earnings growth over time. These characteristics are very attractive when considered in a portfolio context. It is also worth noting that these investment features are in contrast to a large part of the traditional quoted markets in EMs (or passive benchmarks), which tend to be cyclically sensitive and highly correlated with developed markets.
We believe a development lens also aligns investments with policy tailwinds and provides a framework for thinking about how EMs may look over the next decade rather than how they are structured today.
Q. Are economic development and sustainability investing related?
The positive social, economic and environmental aspirations of economic development and sustainable investing (SI) are very well aligned. Development focuses on evolutions in economic structure and SI is concerned with the positive role that financial market participants can play in this evolution. They also share similar long-term objectives, namely, a better, cleaner, more productive and more inclusive future. In 2015, the United Nations outlined 17 Sustainable Development Goals, which focus on ending poverty, fighting inequality and stopping climate change. Investing with a development focus means identifying companies that are helping to facilitate these outcomes.
Q. How does climate change impact economic development in EMs?
We believe lasting economic development depends on four main structural shifts – improving living standards and enhancing inclusiveness, productivity and sustainability – and climate change is a key factor in each of these trends. Importantly, EMs are on the front lines of climate change, facing challenges that could hamper economic development and put human health and capital assets at risk. Physical climate risks such as extreme heat, droughts, supernormal rain events, water scarcity or poor air quality have already created systemic problems for many EMs. At the same time, transition risks stemming from changing policy and regulations can pose financial headwinds, particularly for carbon-intensive industries.
Companies across EMs, in a variety of countries and sectors, recognise climate challenges and are preparing to meet them, either by developing innovative products that help society adapt to climate change, or by shifting business models and corporate policies to mitigate the risks. In our view, like every structural theme, climate change causes market dislocation and presents investment opportunities and risks that active investors ignore to their own detriment.
- Equity markets
- Foreign and emerging markets