Devoting More Energy to Country Selection as Success Rates Get More Selective

One of the most unique and challenging characteristics of emerging-market investing is the emphasis on regional nuance: measuring the risks and potential rewards of country-specific allocations. As we strive to clarify our metrics for success, where we invest becomes just as important a consideration as what and how we invest.

Combining selectivity with open-mindedness is key as success is redefined in terms of enhanced profitability and minimized volatility over the long term. Through this lens, country selection must be prioritized even while requiring greater expenditures of time, effort, and human capital.

Taking the Leap

Despite their incredible potential, emerging markets remain a largely untapped and underappreciated opportunity. By the year 2025, annual consumption in emerging markets will increase to an astounding $30 trillion and will account for nearly half of the world's total consumption: 4.2 billion emerging-market consumers out of an aggregate global population of 7.9 billion people.

Much of the reticence likely stems from global macroeconomic concerns, which is understandable: analysts from the Organisation for Economic Co-operation and Development (OECD) expect global growth slow from 3.7% in 2018 to 3.3% in 2019, with only a slight uptick from there to 3.4% in 2020. In light of this, investors may view developing regions in Asia, Africa, and Latin America as particularly vulnerable until the outlook improves.

Contrarian or value-focused investors can view this as a chance stake a claim where others dare only to tread lightly if at all. Global big-picture concerns need not deter the valiant, as the outlook brightens when we home in on developing regions: GDP growth in Latin America is expected to increase from 1.3% in 2017 to 2.2% in 2019, while Africa at 3.8% GDP growth in 2019 will easily outpace the United States in that respect. China, meanwhile, despite trade tensions, will remain robust with 6.3% GDP growth in 2019.

Profiting from the digital revolution, the trend towards urbanization, and the middle-class consumer boom in these regions doesn't require such a grand leap of faith, though it does require investors to pinpoint nations with strong growth potential along with a measure of stability. 440 developing-market cities will generate around half of the world's GDP growth during the next 15 years; with so many areas to choose from, effective country selection will be vital to enhancing portfolio returns over time.

Narrowing the Focus

While a risk-reward balance is always warranted, it may be the case that wary investors are placing too much emphasis on the "risk" side of the equation when it comes to emerging-market investing. Not that such concerns are undue: eliminating from consideration, say, North Korea based on its leadership's lack of commitment to informational transparency or Venezuela during times of political unrest may be a sound risk-off policy.

Still, even with the transparency and stability filters securely in place, there's a broad array of promising investment targets with favorable risk-reward profiles for even the most selective among us. A strategy that may prove particularly useful in this regard is to identify countries where the consumer class is emerging quickly and steadily, and using a cluster-based strategy to identify adjacent countries with growth potential.

Asia provides a textbook example of the first strategy, as its middle class is growing in leaps and bounds while; indeed, Asia's middle class is projected to increase from 1.4 billion people in 2015 to 3.5 billion people by 2030, a number which will comprise, 65% of the world's collective middle-class population.

China may strike us as the most obvious investment target, but again, open-mindedness is the key here: as reported by Bain & Company, "50 million new consumers will join the ranks of the middle class in Indonesia, Malaysia, the Philippines, Thailand and Vietnam by 2022, contributing to the region's $300 billion middle-class disposable income" - clearly, new frontiers for emerging-market investing are ripe for exploration.

Africa presents a similarly encouraging scenario for targeted allocations, with The Brookings Institution reporting that Africa's household consumption will increase to $2.5 trillion by 2030 and that in particular, "Seven countries—Nigeria, Ethiopia, the Democratic Republic of Congo, Egypt, Tanzania, Kenya, and South Africa—will soon hold half of the continent's population, and 43 percent of Africans across the continent will belong to the middle or upper classes."

Enhancing this focus with a clustering strategy may simplify the process. For example, targeting the adjoining Turkmenistan and Uzbekistan - both of which are "among the top five countries with the fastest real gains in median income," according to Euromonitor International - may be an interesting strategy for investors seeking to capitalize on the certain rising middle-class demographic segments within central Asia.

Selecting, not Rejecting

If there's any recurring theme here, it's a willingness to explore the unexplored and to see the potential in places where the timorous need not venture. Country-specific emerging-market investing thus requires extra due diligence and perhaps some risk tolerance, but the returns - both financially and in terms of knowledge gained - can be outstanding.

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