Emerging Markets Insights

Investors Turn Cautious in September after a Strong Start to the Quarter

Franklin Templeton Emerging Markets Equity

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Three Things We're Thinking About Today

  1. Brazil has been among the hardest hit by the COVID-19 pandemic, just behind the United States and India in the number of reported cases. However, we have started to see the number of new cases in Brazil start to decline. Ironically, we believe that the government’s decision against implementing a country-wide lockdown at the onset of the pandemic has reduced the likelihood of a second wave. Heavy government spending and monetary policy easing have helped bring some stability to the economy. Moreover, Brazil has continued to implement key reforms despite political noise. In terms of investment opportunities, we continue to favor the financials sector, especially companies with strong capital market exposure. Interestingly, Brazil’s stock exchange itself has a strong sustainability agenda, while environmental, social and governance (ESG) principles are not only implemented within the exchange itself, but also promoted in the Brazilian stock market broadly. E-commerce is another exciting investment theme, with several large players competing in the online space. As in other countries, the COVID-19 crisis has accelerated the adoption of internet-based retailing in Brazil. Despite continued uncertainties, our view on Brazilian equities is generally positive.

  2. The COVID-19 pandemic has underscored the importance of health care in China, reinforcing existing structural trends that could drive a new wave of innovation in the country. Multiple factors are propelling domestic drug and medical device development including rising health care demand, an aging population, growing lifestyle diseases and rising income, coupled with government efforts to strengthen the health care system. In addition, the growing numbers of overseas-educated Chinese scientists and entrepreneurs returning to the country constitute an abundant pool of homegrown talent. We see greater long-term potential in innovative drug makers with strong portfolios or pipelines of treatments, compared with generics companies that are likely to face price pressures from government reforms. Some Chinese biotech firms have shown remarkable speed in bringing novel treatments to market. Companies in the pharmaceutical outsourcing industry also show promise. Meanwhile, we also see examples of innovation in medical equipment makers—leading domestic suppliers, which already have a cost advantage over foreign competitors, whose growth could be encouraged on the back of government policies supporting localization. We think these companies reflect a new breed of innovative enterprises that could transform health care outcomes in the years ahead. Together with flourishing capital markets, favorable policies and motivated talent, a vibrant ecosystem is potentially taking shape.

  3. Company engagement remains a crucial part of emerging market (EM) investing. Bringing about better corporate behavior and a better understanding of companies’ responsibilities toward all stakeholders are efforts we continue to push in our stewardship of client capital. The tone of engagement in EMs has shifted in recent years: companies that formerly took a narrow, hard-nosed approach to returns are adopting more accommodative measures. In countries such as South Korea, South Africa and Brazil, companies are placing more emphasis on ESG issues. We have seen leading companies in South Korea publicly apologize for governance missteps and manage their balance sheets more effectively through returning capital to shareholders. ESG reporting has become mandatory in some countries, a trend we expect to continue elsewhere. The ESG conversation is changing further amid the COVID-19 pandemic, with a greater focus on the social impact of policies. Many governments are supporting jobs, while companies are more cognizant of the reputational risks of layoffs. ESG has become more important, with companies considering it critical to sustainable business performance. In our view, this “delta” of improving ESG in EMs is a further tailwind supporting the secular outlook for the asset class as the world emerges from this crisis.

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WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.