How three emerging markets might shed their 'marmite' reputation

Varun Laijawalla notes that some investors will treat emerging markets like Marmite. The UK-based Portfolio Manager for Emerging Markets Equities at Ninety One notes that the famous British spread comes with a love it or hate it reputation. EMs can elicit similar reactions, often serving as either the best or the worst performing geographic market category. Volatility in these markets has tended to be high, driven in part by the influence of strongman leaders like China’s Xi Jinping. Now, however, Laijawalla sees three markets undergoing some degree of structural change that has their equities behaving a bit more like developed markets, just as volatility in developed markets is making them look a bit more like EMs.

Laijawalla explained how South Korea, Brazil, and India have each undergone certain changes in their political and business environments that offers investors both upside opportunity and less volatility. He noted whether those trends might continue in each country and how Canadian advisors might want to view these markets in light of new changes.

“When you think about the inherent cyclicality of this asset class, historically, I think a big driver has been the weakness of institutions versus developed markets,” Laijawalla says. “The ability of strongman leaders to influence outcomes at a state level are enormous. And it’s that weakness of institutions and strength of strongmen that has led to these shorter, sharper cycles in the asset class. The question then, is, will that ever change?”

South Korea: political consensus and chaebol buy-in

Laijawalla begins his survey with South Korea, which has recently emerged from a period of lame duck government where different parties controlled the Presidency and the National Assembly. Following Presidential elections in June, the centre-left Democratic Party now has a mandate for structural reform that Laijawalla says is aiming to emulate the value-up programs embarked upon by Japan over the past decade.

One election may not make for structural reforms as yet, especially in a country with a fraught political past like the Republic of Korea. It’s notable, too, that large-scale business conglomerates owned by a few interconnected families called chaebols continue to play an outsized role in the country’s economy. Laijawalla notes, though, that the new reforms underway in South Korea are aimed at resetting the incentive structure of companies away from their elite minority shareholders (the chaebols) and towards their majority shareholders. The test, he says, will be if meaningful wealth creation in South Korea can extend beyond those wealthy families towards more of the population.

Brazil: anybody but Lula

Brazil might be the most cyclical market within the MSCI emerging markets benchmark. Investing in the country tends to feel like chasing a shadow, Laijawalla says, with successive governments swinging wildly on policy. He notes, though, that there is huge room to run in Brazilian equities as local pension funds are highly incentivized to invest in government bonds that offer yields around fourteen per cent. Domestic allocations to equities are around six to seven per cent, resulting in a very uncrowded equity market. Political consensus seems to be coalescing around an anyone but Lula message and so when the next presidential elections come next year it is likely that President Lula is ousted in favour of a more pro-business candidate. In that event, Laijawalla sees an equity market with room to run that will react favourably.

India: coalitions curbing a strongman

India under Prime Minister Narendra Modi has been a story of significant structural reforms aimed at the country’s famously Byzantine bureaucracy. Those reforms, though, saw an increasing amount of power centralized under Modi and the ruling BJP party. Laijawalla describes some of Modi’s governance style as ‘hubristic,’ especially in both the nonchalance with which India continued to purchase Russian oil and in the adoption of exclusionary religious policies. General elections in 2024, however, saw the BJP lose their absolute majority in Parliament. They have since needed to seek coalition partners which Laijawalla says is curbing Modi’s more extreme tendencies.

At the same time, Laijawalla says Indian wealth creators have become more disciplined as a new generation of more experienced and often foreign-educated leaders take the reins. Domestic market flows have responded accordingly. Pre-COVID, around $12-13 billion USD per year flowed into the Indian market. Post-COVID that figure has risen to over $30 billion. There may be yet more room for that domestic investment story to take hold.

Canadian investors and EMs’ promise

While each of these stories comes with their own unique drivers, Laijawalla notes that these three markets have seen overall volatility levels decline significantly. At the same time, developed market volatility has risen. He believes that now there is a gap between the perception and the reality of these markets. Moreover, he notes that the US dollar has begun to decline significantly and that Trump administration trade policy favours a softer dollar. Dollar weakness has typically been a boon for emerging markets.

Over the past decade in the United States, he says, everything has gone right. The key market drivers of revenue growth, margin growth, currency valuation, and net issuance of new stock all served to support US markets. In emerging markets there was revenue growth, minimal margin growth, some currency issues, and an overabundance of net issuance that served to work against those equity markets. Now the US is facing currency issues and other drivers may be less secure. At the same time, emerging markets have dealt with some of their issuance problems while retaining other growth dynamics.

“That is why the investment community need to reconsider how they allocate to emerging markets, because there is a time to be invested and a time to be more cautious,” Laijawalla says. “We are approaching that time to be invested.”