A common thesis before making any investment involves making the best possible return among all the available avenues and scenarios to invest. The returns on investments are directly correlated to their growth rates. Hence, while investing, the rate of growth plays a detrimental role in the decision of any investment. Therefore any investor looks for avenues and markets that can provide superior growth rates for extended periods.
An emerging market is one such avenue that attracts investors from all over the globe. They are markets that have some characteristics of a developed market but does not fully meet its standards. These economies are in the process of transition from being emerging markets towards developed markets. Economists classify these markets as a society transitioning from controlled markets to free-market-oriented-economy with increasing economic freedom, expanding the middle class, improved standards of living, social stability, and tolerance.
We have seen a lot of emerging markets since the 20th century. During the 1920’s the US was an emerging market and saw a rapid increase in growth rates with the period being referred to as the roaring ’20s. Again in the 1960s, Japan increased its growth rate rapidly, creating tremendous wealth for investors. In the 1990s, our very own country became an emerging market for FII’s, and we saw one of the best bull markets in the history of the country. Again during the 2000s, China saw a phase of rapid economic growth. Emerging markets continue to appear in every decade, and an investor with a solid ideology can benefit from such exchanges.
There are specific indicators that can give indications about an emerging economy. These include
- High growth Rate- The most obvious characteristic of an emerging market is the high growth rate it provides to investors. These markets tend to expand rapidly due to the “catch up” effect. Another confirmation sign of an emerging market would be that these growth rates are fuelled mainly by a specific demographic characteristic, i.e., the young generation.
- Returns and cost of capital- It is usually seen that as firms mature, in the long run, their backs become equal to their cost of capital. However in emerging markets, firms continue to generate returns well above their cost of capital at a consistent rate for longer periods.
- Bond Markets- The debt segment of the markets is not well-developed. Hence the bond yields are high in such markets, and the rating agencies frequently assess them.
The Correct Approach to Investing in Emerging Markets:
Investing in emerging markets entails a lot of risks ranging from defaults, frauds to political turmoil. Hence it is recommended that investors follow a strategic approach that reduces the risk and increases returns for the investor. The core of the strategy must be:
- The consumption story- One of the most prominent themes to invest in emerging markets is the consumption story. Emerging markets witness rising population trends. The rising population leads to an exponential increase in the consumption of the country. Add rising income levels to it, and the consumption sector is no short of a gold mine to the investor. However, we also recommend that investors proceed with caution and look to invest in companies that have low debt and higher cashflows. These companies will create consistent wealth for its shareholders for more extended periods.
- Durables, Necessities, and Commodities- Consumer durable segment is one of the most lucrative parts to invest in. Automobiles and other sectors also are attractive avenues to invest in an emerging market. However, these avenues will only generate wealth if rising income levels of the economy supplement them. An investor must confirm this before selecting these avenues to invest. If an investor is knowledgeable about commodities, he must invest in the commodity sector of the emerging market as well, as rising commodity prices increase the performance of emerging markets.
- Betting on Credit- The growth in any emerging market is led by consumption. That consumption is fuelled by credit in the economy. Hence one of the best ways to participate in the growth is to bet on credit expansion in the country. Financials and banks are one of the best sectors to create wealth from a ten-year perspective. Credit expansion and financialization of savings create tremendous growth for this sector, which leads to mega returns for investors. We always recommend that an average investor must allocate capital in the leading financial company of the country. The rationale behind this is relatively simple- As emerging markets age, there is massive consolidation in the financials space, giving market leaders a higher and higher market share. The longevity of growth for these companies is created, allowing them to compound capital for extended periods.
Growth path of India–
The Indian market scenario is exciting to an investor. Ever since the liberalisation of 1991, the Indian stock indexes have continued to clock gains for nearly three decades now. We continue to believe in the Indian growth story and are extremely optimistic about the prospects of growth for the next decade. Indian investors find themselves in an extremely advantageous position, and they have one of the best opportunities to make a strategic portfolio with a long term perspective. Our recommendations for investors include:
- Demographics- The demographics of India is unique. It is estimated that the young generation will be the largest age-group in the country by 2025. Also, the rising income levels provide a lot of scope for spending and consumption. Hence an investors must allocate the right amount of their capital towards FMCG, consumer durables, and the auto sector.
- Export- It is expected that India will become a significant exporter in the world economy by 2025. To take advantage of the growth wave coming from exports, an investor must focus on the core competence of the country engaged in exports, i.e., the technology and the pharma sector. Both of these sectors have a track record of generating returns via exports. Hence, investing in these sectors will be an attractive opportunity for investors.
- Credit Growth- The massive financialization of savings that will occur due to rising standards of living will create superior credit growth in the future. This credit growth will most likely benefit the financials, especially the market leaders.
- Infrastructure- Infrastructure is necessary in any emerging market for development. The government’s commitment towards the development of infrastructure can result in value creation in infra companies. However we advise caution against companies with excessive debt and low growth rate.
The Next Wave?
Currently, India, China, and Southeast Asian countries are experiencing a wave of high growth. However, history has taught us that there are limits to growth. We saw this in the USA in the 1930s and to Japan in 1985. A similar trend is being observed in China. This prompts us to identify the next stop for this wave of growth. We are observant on the continent of Africa, currently a frontier market as the next potential destination for high growth. There are trends in better health spending and education emerging in some countries. This is likely the first step in the development of human capital. Africa has vast mineral reserves, which can create massive growth opportunities for the continent and specific countries in the future. An investor who wishes to take the early bird advantage must keenly follow all the developments in the African continent.
With that, I firmly believe that the readers now have a thorough understanding of the emerging markets and can successfully navigate through them and build strategic long term portfolios for achieving superior returns in the future.