A world on fire and a $5.5 trillion need for capital
Will Scholes, co-fund manager of the Premier Miton Emerging Markets Sustainable Fund, puts a long-term lens on emerging markets (EM) investing.
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Putting a long-term lens on EM investing
The year 2023 closed with a grim milestone for EM investors. With China’s accession to the World Trade Organisation in December 2001, the start of 2002 has become a typical start date to illustrate EM equity performance in charts. Through this long-term lens, MSCI’s Emerging Markets index could still show long-term outperformance versus the widely-used benchmark of the global equity investor, MSCI World. In December 2023, after 159 months of surrendering relative performance, EM fell behind.
Less dispiriting was the flow of strong economic data from major emerging markets in 2023. In fact, 2023 was a year in which the case for investment in EM really started to gain traction. Lesser inflationary pressures and recovering goods trade allowed some EM central banks to lower interest rates ahead of the Federal Reserve action. Synchronised capital spending on the energy transition and artificial intelligence (for which EMs are key suppliers), and higher local investor participation all helped to resuscitate interest.
The flow of capital to EM funds remains moribund, however, and share prices reflect that. Measured on a price-to-book multiple, EM has sunk to a 20-year low relative to the developed world. But, that flow of capital was nowhere near as feeble as that seen beyond the scope of public equities, across the developing world as a whole.
The Triple Agenda and a world on fire
Developmental finance flows – which ought to be blind to economic cycles – reversed in 2023. In a piece for the international media organisation Project Syndicate titled ‘The World is Still on Fire’ , American economist Larry Summers and N.K. Singh, President of the Institute of Economic Growth, have highlighted quite how dramatically the developing world has been failed.
No wonder the authors express horror in the piece. In July 2023 they had led the publication– of a report – in partnership with the government of India – insisting on development bank reform.
That piece (The Triple Agenda) lays out the need for additional annual external financing of $500bn, recommended to catalyse private investment in order to finance the climate transition and to make progress on other health and education-related UN Sustainable Development Goals.
Instead, the reverse occurred. Higher interest payments meant net outflows and so bear most of the blame, in tandem with the effective closure of capital markets to new debt issuance from the poorest countries. $68bn of private capital flowed out from developing countries, accompanied by $39bn of non-concessional funding (with the International Monetary Fund at the centre of that figure, comprising $21bn).
The failure of aid and investing in EM
So what? What does this failure in aid have to do with investment in publicly-listed equities across the likes of Mexico, China or India, that do not rely on multilateral sources of funding?
Well, it highlights the systemic nature of finance and the unintended impact of policy. While isolating the single root cause of high interest rates is tricky and opinions differ, singling out some major contributors is less controversial.
“Industrial policy” today is a phrase that has gained acceptance as much by its ubiquity as by economic soundness. A broad, me-first policy concept that likes to pretend it is actually “national security”. This may not be the sole reason why the US economy, for example, is running so hot, but it is certainly stoking the fire. Such policy means large fiscal deficits at a time of high inflation and high debt, incurred to finance the relocation of jobs and subsidise costs to a competitive level, all of which masquerades as a necessity of economic and national security.
Supporters will say these incentives drive competition and lower costs. Yet, electric vehicle affordability remains poor in the US. General Motors is reducing the proportion of EVs coming off the line, not increasing it, because demand isn’t there.
The same incentives are driving dubious corporate behaviour from would-be beneficiaries of tax credits: committing to full supply chain establishment onshore in the moment, only to concede that reshoring some key component or mineral is simply not commercially viable later.
The US may have been the first, it will not be the last. The EU now wants to protect a solar industry it abandoned long ago. History will judge whether programs such as the Inflation Reduction Act either reduced inflation or brought about energy transition any sooner.
If this seems far-removed from conflict or famine in the developing world, it should not. Trade squabbles over solar modules, battery cells, even cancer drugs are small steps toward higher costs for all. But more than that it is the opportunity cost: sucking in capital to the developed world, creating centres of production in duplicate, even triplicate, and crowding out other uses for that capital. Certainly, this is a step away from a “just transition” in which no people, workers, places, sectors, countries or regions are left behind in the transition from a high carbon to a low carbon economy.
Equity markets compound this problem. Higher interest rates are a headwind for companies aiming to finance investment needs in areas of growth. But, even when those needs are fully funded, share prices of high growth companies fall as investors “rotate” from Growth stocks to Value stocks.
This makes its way into corporate engagement, with investors demanding higher capital returns even when faced with overwhelming evidence that rates of return on reinvested capital exceed those rates most investors can access if cash is returned.
This is all an age-old ebb and flow and makes a market. It drives the dispersion of share prices which active managers need to survive. But it is also characteristic of short-term and fundamentally local thinking, despite an onslaught of global problems.
Particularly harmful is the strange calculus around climate scenario analysis, in which long-term capital is incentivised to seek low carbon geographies in supposed support of decarbonisation.
This naturally fails to consider what use net zero here in the UK can be if it comes without the same in Indonesia or Nigeria, or India, for example. These are growing populations with low per-capita carbon emissions.
The question is not whether those emissions will rise as those economies develop, but how fast. Incorporating that forward-looking carbon budget with a clear-eyed focus on what carbon we consume, not just what we produce, would deliver better decision-making today than pretending it isn’t there.
The need for capital
2023 was not without its highlights. In April, we launched the Premier Miton Emerging Markets Sustainable fund. Our aim as fund managers is to deliver long term capital growth through investing in companies which are delivering measurable societal and environmental progress in alignment with the UN Sustainable Development Goals (UN SDGs).
Later in the year, the UK’s Financial Conduct Authority – following investor engagement – amended draft proposals to its Sustainability Impact label to acknowledge the role of secondary (i.e. public equity) capital, accompanied by engaged stewardship, in delivering impact.
The contra-flow of development funding witnessed in the year is tragic, but it is a constituent part of a much greater capital requirement. The $500bn annual requirement outlined by the Centre for Global Development (CGD) report is intended to catalyse additional private capital input to hit a bigger $3tn annual figure.
At a global level, BloombergNEF put the annual investment needs to reach net zero in time at $5.4tn annually. We want to be part of that body of patient, engaged capital.
We aim to deliver non-concessionary returns without greenwashing or compromising on franchise quality and, in so doing, draw more capital into long term investment in countries where it will go furthest in driving progress toward the SDGs.
We still have time left to do better in 2024.
