The following questions – focused on the resurgence in emerging markets – highlight the three key themes helping to drive investment in this space: the rise of the consumer, an increase in technology and infrastructure demand, and buying opportunities.

Our in-house experts highlight three key themes helping to drive emerging markets opportunities. They also address several questions we've received about this unique asset class, including how emerging markets can help enhance a well-diversified portfolio.

The rise of the consumer

As incomes rise and urbanization expands, consumption rates in emerging markets are rapidly outpacing developed markets. Indeed, Emerging Asia is set to dominate consumption by the 2050s. As illustrated in Chart 1, spending patterns will increasingly resemble those seen in middle- and high-income economies with changes in consumption amplified by demographic shifts.

Source: abrdn, March 2023. Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed, and actual events or results may differ materially.

Technology and infrastructure demand

Emerging markets dominate global production in tech areas such as semiconductor manufacturing. Meanwhile, growing cities are driving the need for homes, utilities, and transportation. As highlighted in Chart 2, emerging market infrastructure investing is expected to far exceed that of developed markets, with a significant investment gap between now and 2040.

Source: Swiss Re Institute estimates, based on data from Global Infrastructure Hub and Oxford Economics. Estimates are offered as opinion and are not reflective of potential performance.

Buying opportunities

Uncertain US Federal Reserve (Fed) policy and potential consumer recovery in China have helped drive flows into emerging markets. Yet many emerging market companies still trade well below their long-term averages. As indicated in Chart 3, emerging markets are trading at a steep discount to developed markets, and valuations remain attractive.

Source: Bloomberg, 31 August 2023. For illustrative purposes only. No assumptions regarding future performance should be made.

Source: abrdn, Bloomberg, 31 August 2023. MSCI Indices, *MSCI China PE – 12-month forward (rolling), PB – Historic. Monthly data points.

What's on investors' minds?

Given the unique investment opportunities presented by emerging markets, we've aggregated the following relevant questions, and provided answers to help our clients make informed investment decisions.

1. What are the potential risks and challenges that emerging markets investors face in the latter half of 2023, and how might they affect equity markets?

Following a turbulent 2022, this year was widely expected to be a game of two halves: First, an economic slowdown as higher interest rates bite and dampen inflation, and then, a dovish shift in monetary policy. However, with inflation increasingly sticky and growth more resilient than anticipated, this scenario has not materialized. As a result, market expectations have adjusted throughout the year. Investors now expect the Fed to cut rates in early 2024, having previously forecasts rates moving lower as early as September 2023.

The tailwind of policy reversal and potential counter-cyclical recovery should benefit emerging markets. As always, though, the devil is in the details. Listen to our recent Emerging Markets Equities podcast episode where we discuss the potential opportunities and threats to emerging market economies from new trends in globalization: Emerging markets: Opportunities and threats from new trends in globalization.

2. How might a soft economic landing in the US affect emerging market economies, specifically China?

Chinese policymakers have been clear that they want consumers' savings to flow into consumption. However, the spending recovery has been sluggish – and confidence in a recovery is faltering, both domestically and abroad. On top of this, the manufacturing side remains a bit soft, while the real estate sector has been a long-lasting drag on the economy. The country's 5% growth target was viewed as conservative when it was announced; it now looks reasonable. July's Politburo meeting reaffirmed the government's intention to support private investment in the domestic economy. That said, the meeting was light on details and was swiftly followed by fresh restrictions on smartphone usage for children and teenagers, which hurt tech firms. This served as a reminder that a recovery is unlikely to be linear

We will continue to monitor developments in China and leverage our in-country resources to generate investment insights. As it stands, we remain conscious of several looming questions: Will services eventually start contributing to growth? Will domestic households tap into their excess savings? Can China regain investor confidence?

3. How has nearshoring affected the performance and prospects of emerging market companies and economies?

The learnings from COVID and rising geopolitical risk have prompted companies to reconfigure their supply chains. These are now shorter, more resilient, and stable (a trend also referred to as nearshoring or friendshoring). This inclination to factor geopolitical risk into global commercial relationships creates opportunities for companies in specific industries and countries, such as Indonesia and Mexico. We have several positions within our portfolio that could benefit from nearshoring and other structural trends.

Join our latest podcast where host Nick Robinson discusses nearshoring and how the changing structure of global supply chains is affecting the companies and economies of emerging markets: Spring tide: How will EM benefit from nearshoring.

Listen to our recent Emerging Markets Equities podcast episode where we cover Mexico's unmatched nearshoring potential for companies looking to access the US market: New path along the Cordillera: Mexico and nearshoring.

4. How is generative artificial intelligence (AI) expected to affect emerging markets, and what are the potential opportunities and challenges associated with it?

AI is a tech- and hardware-intensive story. We think it will significantly affect emerging markets in the years to come. Emerging markets are home to many of the world's leading manufacturers of microchips and/or components to make associated parts. Many should therefore significantly benefit as countries and companies ramp up spending on AI.

Learn how Asia's dominance in the tech value chain and its central role in the drive towards decarbonization are helping to generate global economic growth: Asia: Leading the way.

Also, abrdn Research Institute (aRI) looks at the five long-term structural themes that it believes will affect the microchip industry: Seeing the macro view for microchips.

5. What emerging market countries do we think will benefit most from the global energy transition?

Energy security remains key. As OPEC+ stands by its decision to support oil prices – in no small part to sustain reform momentum in the Middle East – we expect global investments into the transition to renewable energy to accelerate. Many of the real assets that support electrification and climate resilience are produced in emerging markets, adding further potential for growth.

The concurrent shifting tides that became clearer in the last two years – such as deglobalization and an accelerating energy transition – present a plethora of opportunities for long-term investors. An active investment approach enables investors to sidestep parts of the market that are most exposed to permanent losses while identifying the long-term winners in a changing world. We remain focused on emerging market companies with discernible quality characteristics, strong ESG credentials, and sustainable economic moats. These attributes should help businesses navigate choppy waters and deliver positive returns over the long term.

6. What longer-term themes do we believe will drive opportunities within emerging markets?

The seemingly never-ending geopolitical risks

From many perspectives, geopolitical tensions cause disruption. That said, not all disruptions are negative. For example, shifting supply chains due to US-China tensions has been a positive for Indian and Taiwanese companies. No matter the issues, though, we are optimistic policymakers will make sensible decisions to maintain the status quo. One factor to watch is the return of domestic investor confidence in China.

Favorable demographics

A shift in demographic trends – life expectancy, dependency ratios, as well as education (Chart 4) and skill levels – will drive emerging markets in the coming decades.

Source: abrdn, Haver, World Bank, March 2023.

Most emerging markets have young and growing populations. By 2025, 90% of the world's working-age population will live in emerging markets, according to the United Nations. A younger population typically means a larger workforce, high productivity, and increased consumer spending. It also means more taxes to pay for social programs like education and healthcare. This comes at a time when many western countries are contending with burgeoning elderly populations.

These contrasting dynamics should make emerging markets increasingly competitive compared with their developed peers.

Learn why aRI believes Emerging Asia is set to deliver economic outperformance up to 2050 and beyond: The Asian century? It's only just begun.

China plus-one strategy

Amid geopolitical tensions, companies are increasingly attempting to reduce their dependency on China as a single source of supply. Many are moving production of certain products to neighboring countries to take advantage of their core competencies and comparative advantages. Beneficiaries include India, Indonesia, Vietnam, and Taiwan. Over the long term, companies adopting this China plus-one (C+1) strategy aim to achieve the best of both worlds: the ability to de-risk their supply chains while also tapping into the domestic opportunities of the world's fastest growing markets.

Amid increasing talk of C+1 strategies, there's a real opportunity for India to harness geopolitical trends and local reforms to address its historic weak link of manufacturing: Why the direction of travel bodes well for India's economy.

7. Are increased risk-free rates problematic for emerging market debt?

Increased risk-free rates can pose challenges for emerging market debt. When risk-free rates rise, such as for government bonds in developed countries, investors often shift their focus towards safer assets. This could potentially dampen demand for higher-risk emerging market debt. The result in capital outflows from emerging markets, which puts pressure on their currencies, and pushes up borrowing costs., Additionally, higher rates globally can lead to a stronger US dollar, adversely affecting countries with high levels of dollar-denominated debt.

8. What are the areas of emerging market debt where we see the most value in the current macro backdrop?

In the current macroeconomic environment, areas within emerging market debt may present value. Some local currency government bonds or corporate bonds in sectors less sensitive to interest rate changes might offer opportunities. Countries with strong economic fundamentals, sound fiscal policies, and growth potential could also be attractive. Diversification across regions and types of debt instruments can help mitigate risks.

Article adapted from our mid-year outlook virtual event, "Emerging markets: Ready for a resurgence” panel discussion with participants, including Devan Kaloo, Robert Gilhooly, Brett Diment, and Abigail Watt.

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