Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 568

Emerging market equities are ripe with opportunity

The term ‘Emerging Markets’ (EMs) first emerged (if you’ll excuse the pun) in the early 1980s, and it took several years for the MSCI Emerging Markets Index to be launched in 1988. The EM Index initially consisted of 10 markets and accounted for less than 1% of the global equity universe. Over time, countries have been added and removed from the index, and today the EM Index comprises 24 markets and represents over 10% of the global equity universe. Furthermore, EMs and developing economies contain around 85% of the world’s population and contribute roughly 60% of its GDP at purchasing power parity.

Since the inception of the EM Index, EMs have delivered on investor hopes and outperformed the MSCI World Index (which only represents developed markets), as shown in the following chart. This long-term relative outperformance may come as a surprise to many investors, given it’s been a tale of two halves as indicated by the green and red arrows. In the first 20 years, EMs beat the World Index by around 6.5% p.a. In the last 16 and a half years, however, much of that outperformance was given back with EMs lagging the World Index by over 5% p.a.

Disappointing recent returns have left many investors wondering whether EMs are worthy of their capital. To them, we have a simple answer: Yes. We think this is an unusually attractive time to invest in EMs, and the universe is ripe with opportunity for bottom-up stock pickers. But like any investment universe, EMs are not without risk. The table below presents three risks to keep in mind and three opportunities to get excited about. It is by no means exhaustive but makes for a good starting point. Let’s briefly discuss each.


In EMs, governance issues are rampant. At many private businesses, investors endure poor capital allocation, related party transactions, and heavy dilution as companies issue ever more shares. It’s all well and good to grow the profit pie quickly, but not when it’s cut into too many slices. China makes for an instructive example: the net profits of listed companies have grown by around 25% p.a. since the early 1990s, but that translated into per-share earnings growth of just 5% p.a., and disappointing equity returns. State-owned enterprises (SOEs) layer on additional governance risks, as their priorities are often not aligned with those of shareholders. Whilst the weight of SOEs in the EM Index has declined in recent years, they still account for a substantial chunk of the universe today. But EM companies are not all alike. Mindful of elevated governance issues, we have a strong preference to partner with owner-managed businesses. Managers who are themselves shareholders are often more aligned with our clients’ interests and tend to make better capital allocation decisions. Current examples in the portfolio include our longstanding positions in Jardine Matheson, NetEase and Kiwoom Securities.

EM companies are not homogenous, and nor are EM countries—even if some investors treat them that way. In reality, every market is unique and presents different opportunities and risks. A quick glance at valuations confirms this, as shown in the following chart. For example, India appears very expensive on a variety of aggregate valuation metrics. Unsurprisingly, we are struggling to find many attractive ideas there, though with hundreds to choose from, we have found some, including HDFC Bank. Compared to India, China looks inexpensive—but it comes with very different risks, and commands a 25% weighting in the EM Index. Given the risk, that is higher than we are comfortable with, and as active investors, we can afford to be selective. We have found relatively more ideas in other countries.

China calls to mind another source of risk: geopolitics. In that, China is hardly alone—as we were painfully reminded in 2022 when we wrote our small position in Sberbank of Russia down to zero. Between military campaigns in the Middle East and presidential campaigns in America’s Mid-West, geopolitical uncertainty is high. We address that not by trying to guess what is in world leaders’ heads, but by focusing on companies and their prices. As bottom-up investors, we spend most of our time estimating what businesses are truly worth, and only buy shares that trade at a deep discount to our estimate of intrinsic value. This discount provides our first and most important line of defence against permanent losses. When we buy a stock, we also carefully manage the weights of our positions. But in some cases, no price is too low to guard against catastrophic events, and the right weight to have is none.


Those fearful factors are well known, but they are only half the story. Over the long-term, the price you pay for an asset is one of the most important drivers of future returns. After years of disappointing returns in EMs, many investors have headed for the exits, and it remains an under-owned asset class. The good news is that this has translated into substantially lower valuations versus stocks in the developed world. Consider the cyclically adjusted price-to-earnings (CAPE) ratio, a well-established barometer for the expensiveness of a market, and a reasonable indicator of long-term real returns. In aggregate, EMs trade at a CAPE ratio of around 12 times, which is low versus its own history, and low compared to about 20 times for world markets. EMs are also discounted versus world markets on conventional price-to-earnings, price-to-book, and price-to-free cash flow measures—to name just a few.

And it’s not just the stocks that look cheap. EM currencies trade at deep discounts to their valuations on a purchasing power parity basis. An equally-weighted basket of the largest EM currencies, such as the Chinese yuan, Taiwan dollar and Korean won, is as cheap as it’s been since the early 2000s—trading at around a 20% discount to the US dollar. Historically, much of the volatility experienced in EMs has been due to currency fluctuations. But given many EM currencies already appear cheap today, there is a lower-than-average risk of a nasty currency shock. Indeed, what has been a headwind for EMs could be a tailwind going forward.

Lastly, the gap in valuations between cheap and expensive shares within EMs is unusually wide relative to history, as we discussed in December. Apart from the extremes of the last few years, the only time this valuation gap has been wider was during the Asian Financial Crisis in the late 1990s—arguably a once-in-a-lifetime buying opportunity. In our view, the opportunity for stock picking to add idiosyncratic value looks unusually good today.

We continue to believe it’s an exciting time for EMs. Whilst recent performance has been disappointing for EM investors, it has provided a great setup today for long-term returns: attractive valuations, undervalued currencies, and wide spreads between cheap and expensive stocks. We think our bottom-up approach is well placed to navigate the risks and capitalise on the opportunities.


Shane Woldendorp is an Investment Counsellor at Orbis Investments, a sponsor of Firstlinks. This article contains general information at a point in time and not personal financial or investment advice. It should not be used as a guide to invest or trade and does not take into account the specific investment objectives or financial situation of any particular person. The Orbis Funds may take a different view depending on facts and circumstances.

For more articles and papers from Orbis, please click here.



On the virtue of owning wonderful businesses like CBA

Has passive investing killed small caps?

Is there still value in high dividend-yielding companies?


Most viewed in recent weeks

Meg on SMSFs: Clearing up confusion on the $3 million super tax

There seems to be more confusion than clarity about the mechanics of how the new $3 million super tax is supposed to work. Here is an attempt to answer some of the questions from my previous work on the issue. 

Welcome to Firstlinks Edition 566 with weekend update

Here are 10 rules for staying happy and sharp as we age, including socialise a lot, never retire, learn a demanding skill, practice gratitude, play video games (specific ones), and be sure to reminisce.

  • 27 June 2024

Australian housing is twice as expensive as the US

A new report suggests Australian housing is twice as expensive as that of the US and UK on a price-to-income basis. It also reveals that it’s cheaper to live in New York than most of our capital cities.

The catalyst for a LICs rebound

The discounts on listed investment vehicles are at historically wide levels. There are lots of reasons given, including size and liquidity, yet there's a better explanation for the discounts, and why a rebound may be near.

How not to run out of money in retirement

The life expectancy tables used throughout the financial advice and retirement industry have issues and you need to prepare for the possibility of living a lot longer than you might have thought. Plan accordingly.

The iron law of building wealth

The best way to lose money in markets is to chase the latest stock fad. Conversely, the best way to build wealth is by pursuing a timeless investment strategy that won’t be swayed by short-term market gyrations.

Latest Updates

Financial planning

Our finances should enable and not dictate our lives

Most people would prefer to have more money than less of it. But at what point do the trappings of wealth and success start to outweigh the benefits of striving for more?


This vital yet "forgotten" indicator of inflation holds good news

Financial commentators seem to have forgotten the leading cause of inflation: growth in the supply of money. Warren Bird explains the link and explores where it suggests inflation is headed.


Emerging market equities are ripe with opportunity

Emerging markets offer compelling value compared to history and the stretched valuations of developed market equities. Investors can benefit from three big tailwinds, but only if they are selective.


Tomorrow's taxpayers pay for today's policy mistakes

Less affordable housing isn't the only thing set to weigh on Australia's younger generations. If new solutions for pension deficits and the use of resource revenue aren't found quickly, tomorrow's taxpayer will foot the bill.

How would a switch to nuclear affect electricity prices?

The Coalition's plan to build seven nuclear power stations in 15 years faces scrutiny due to high costs and slow construction. And it is unlikely the investment would yield cheaper energy for Australian households and industry.


Reader feedback from our 2024 survey

Articles that are easy to understand, quick to read, and credible; being able to engage via the comments section; and keeping Firstlinks free and independent are just some of the features valued by our readers.


Have your say on Firstlinks and the topics we cover

We’d love to hear your thoughts on Firstlinks and how we can make it better for you. If you’d like to help us out in a just a couple of minutes, please take our short survey.



© 2024 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.