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Mastering the art of differentiation: sifting out the gems in emerging market investments in 2022

19 Nov 2021

Differentiation, knowing where to look and constructing resilient portfolios will be the key to successful EM investing in 2022.
Discerning opportunities in EM investments in 2022

Assets across Asia, the Middle East and Africa are trading at historically cheap valuations, raising the allure of emerging market (EM) investments. This year the challenges have outweighed the opportunities in many areas, making differentiation, knowing where to look and constructing resilient portfolios the key to successful investing going forward. Elevating differentiation to an artform might very well become the mantra for EM investments in 2022.

Volatile growth, an uncertain global outlook, regulatory changes and a focus on inflation are combining to create a maze of factors that need to be navigated carefully. While indicators including the MSCI Emerging Markets Index look set to overcome the downtrends that characterised1 the first part of the year, generating successful returns is becoming an artform as well as a science and continues to require a keen eye.

Just as the outlook for emerging markets became hazier in 2021, with pandemic disruption lasting longer than for advanced economies, it also exposes a myriad of opportunities for those willing to look carefully. Here we discuss some of the factors that will separate the winners from the losers as we move into the final quarter and look ahead to 2022.

“For international investors, there’s plenty to pick from in Asia’s emerging markets,” said Eric C. Robertsen, Global Head of Research & Chief Strategist, Standard Chartered. “Growth coming back is key, because it’s important for attracting new capital or refinancing existing debt.”

More divergence

Emerging market and developing economies will expand 6.4 per cent this year and 5.1 per cent in 2022, according to the International Monetary Fund’s latest predictions2, largely driven by emerging and developing Asia.

But within that, there’s likely to be less synchronisation and more volatility, uncovering some positive surprises. For emerging economies, the ability to implement reforms, investment in clean energy and in energy security will continue to set the tone for investor sentiment and have the potential to reveal opportunities – particularly in Asia and on a case-by-case basis.

As the prospect of more volatility looms, one differentiator may be debt levels, and to what extent the return of growth can help economies manage debt piles – including those that swelled as governments spent to ward off the economic effects of the pandemic. Through that lens, South Asia looks compelling over the next 18 months, as does North Asia, with the export-heavy economies of South Korea3 and Taiwan4 looking remarkably resilient.

“It’s important to buffer your portfolios, to protect against volatility,” Mr. Robertsen said. “While high-beta opportunities exist in some other regions, Asia will remain an important part of investor portfolios due to its less fragile nature, albeit offering slightly lower beta.”

The three overarching themes that characterised 2021 – a slowdown in China, fears of the US Federal Reserve starting to tighten policy, and worries that global inflation5 may spiral – will start to fall by the wayside as we head into 2022, giving space for growth to pick up and investor capital to flow back.

High yield credit

One area with tempting valuations is high yield credit, which has started to cheapen up. Elsewhere within emerging markets, rates can be a tricky area to navigate until the outlook and position of the US Federal Reserve becomes clearer. On the foreign exchange side, there are likely to be good opportunities as international interest rates rise, creating carry opportunities.

India represents an interesting dichotomy, with strong portfolio inflows into the Indian equity market offset by the prospect of rupee weakness. The inflow of foreign money and the huge liquidity in the market suggest that India will remain an attractive FDI destination for many years to come. Its strong domestic market and an encouraging government pushing through wide-ranging reforms in taxation and the rupee-dollar parity continues to add additional appeal.

Mastering the art of differentiation in EM investments in 2022

Demand for oil

Another major theme for emerging markets is the outlook for oil and the bifurcation effect this has. Higher oil prices are likely to benefit countries including Nigeria, Gabon, Angola, Oman and Bahrain, and this theme has not yet been incorporated in the price of the hard currency bonds of those countries.

On the other hand, energy importers with large external funding needs, like Turkey, are likely to suffer as the price of oil increases.

More broadly, investors need to make a call on whether the price, availability and direction of oil will be an important macroeconomic factor as we move into next year, and what this means for their portfolios.

“In places like Nigeria and Angola, we’re beginning to see investor appetite coming back as commodity prices continue to rise,” said Sharad Desai, Global Head of Financial Markets Sales, Standard Chartered. “We also continue to see a case for investment in Asia and in other parts of Africa because the post-Covid recovery is increasing the demand for commodities even as the world moves towards renewables.”

Sustainable investing

Environmental, social and governance (ESG) factors, the geopolitical lines drawn by the COP26 summit and the transition to renewable energy will all remain key themes as we move toward the end of the year. Investment momentum in companies and technologies that aim to improve sustainability is gathering pace and that’s positive for metals and mining products and their producers – in particular for copper, nickel, cobalt and lithium.

Using some of these themes to be selective about which nations and asset classes to invest in will remain at the heart of any emerging market investment strategy. Asia remains more robust and is likely to be slightly less volatile than other emerging markets; there are also some interesting opportunities emerging for those taking a long-term view on India and some of the African frontier markets like Ghana.

While the path ahead may not always be smooth, many EM assets are trading at attractive valuations and offer opportunities even amid a slower-than-anticipated recovery from the pandemic disruption.

Whatever strategy you choose, it’s wise to keep an eye on the liquidity of your investments, to be ultra-selective and to stay cautious. 2022 is lining up to be a year of opportunities for active managers, with plenty of investments to pick from and many ways to slice and dice them. More opportunities will emerge as the dynamics continue to shift and they offer compelling propositions for international investors willing to sift out the gems.

This article is based on themes discussed during a panel discussion at Standard Chartered and Bloomberg Media’s recent investor forum – Emerging markets 2022: Investment strategies for a brave new world. View the recording.