Emerging Markets Investing

Emerging Markets Investing

The Delta Perspective

Attractive Opportunities for the Experienced Investor


Authors: Geoffrey Fink, Michael Blockx and William Martin

Press coverage and market sentiment have recently been bearish on investing in emerging markets. Despite some short-term concerns ranging from rising inflation to slowing growth and geopolitical tensions, strong economic fundamentals, combined with attractive valuations for assets in these markets, should allow experienced investors with longer-term horizons to generate attractive returns.

Fundamentals Support Investment Attractiveness

- Emerging markets are expected to be the principal drivers of global economic growth over the medium term: the IMF projects that emerging markets’ GDP will grow on average twice as fast as that of developed markets, accounting for 74% of global GDP growth through 2017.
- Demographics will remain a key driver of economic development. According to UN predictions, emerging-market populations are expected to add close to 400m people between 2012 and 2017. These populations will remain relatively young, with an average age of 27 in regions such as the Middle East and the Indian subcontinent. Moreover, the UN predicts that while dependency ratios—the ratio of people younger than 15 or older than 64 to the working-age population (those aged 15-64)—across the developed world are rising to worrying levels, in emerging markets they will decline by 2% by 2020, resulting in an increasing economically active population able to support the growth of emerging economies.
- In 2025, 4.2 billion people will be sufficiently economically affluent to be considered part of the “consuming class” – an increase from 2.4 billion in 20101. This indicates that the development of the emerging markets middle class is expected to grow steadily, resulting in EM consumption increasing at a pace of 6.3% per annum (CAGR ’10-’25), to account for 47% of world consumption in 2025 (up from 32% in 2010)2 (see Figure 1). This is a significantly higher growth rate than that expected to be seen in the developed world.


Attractive current valuations and capital under-allocation create long-term upside

According to the IMF and the Thomson Reuters Stock Market Ratios of January 29th 2014, emerging-market equities continue to be valued relatively cheaply compared with developed markets based on price/earnings to growth (PEG) ratios3, implying that growth is significantly cheaper to acquire in emerging markets than in developed markets4 (see Figure 2).

In a recent survey of fund managers published by Bank of America Merrill Lynch on global fund managers, it was noted that in the beginning of this year a net 15% of equity investors were underweight in emerging markets. This market allocation trend is in-line with the lows seen in 2001 (following 9/11) and late 2008 (during the global financial crisis), and is in stark contrast to the net overweight of 40% in early 2013. There is meaningful under-allocation of capital overall to emerging markets, and that is especially true of capital invested in private equity.5
Allocations are likely to normalise over the upcoming decade – resulting in growing competition for attractive assets in these markets, driving increases in valuations and attractive returns for those who invested at the right time.

Unlikely Repeat of the Asian Financial Crisis of 1997

In recent weeks emerging-market conditions have been compared to the 1997 Asian financial crisis. This comparison is fundamentally inaccurate. We note that emerging markets have shown greater levels of monetary and fiscal responsibility in recent years.
Monetary policies have reflected lessons learned from 1997. Many countries have chosen to accumulate significant foreign-exchange reserves and have adopted floating exchange rates—eliminating currency pegs to the US dollar, and therefore, the risk of a sudden collapse in currency exchange rates is significantly lower today. Emerging-market currencies have already experienced a gradual readjustment (a steady 28% decline since January 2010), reducing the odds of an abrupt adjustment. Moreover, IMF figures also confirm a long-term decline in external debt as a percentage of GDP from a peak of 41% in 1999 to 25% in 2013, which materially lowers the risk of a currency shock. These economies are further strengthened by the fact that many countries have had current accounts in surplus in recent years (Figure 3).
Emerging Markets: Opportunity for Experienced Investors
All in all, despite overall optimism, investors today should remain cautious and watch closely for specific economic and political risks. There is no such thing as a single “emerging market” today, and opportunities as well as risks must be assessed on a country-by-country basis (see Figure 4).

Properly selected emerging markets will continue to offer significant opportunities for investors to realise attractive returns on their capital. Investors need to be selective and diligent when considering vehicles through which to allocate capital to these high-growth markets. Managers with significant on-the-ground experience and market-by-market know-how should be able to selectively source attractive deals and ensure appropriate structuring, particularly around currency risk, which is instrumental to manage potential risks and to ensure attractive returns.
An abridged version of this blog appeared in The Economist Insights, 12 June 2014. 
1 Consuming class: daily disposable income in >$10; below consuming class: <$10; incomes adjusted for purchasing parity, McKinsey Global Institute analysis
2 McKinsey Global Institute analysis
3 Price-Earnings-Growth ratio: a valuation metric used for determining the relative trade-off between the price of a stock, the earnings per share and the company’s expected growth
4 Country PEGs calculated using the Price-to-Earnings ratios of the country stock market divided by the nominal country GDP growth rate
5 Emerging markets account for approximately 27% of public market capitalisation versus 38% of global GDP, while they represent only 12% of total private equity capital raised in 2012

Authors' bio:

Geoffrey is a Managing Partner and Head of Investments at Delta Partners with over 17 years of experience in Corporate Finance, Private Equity and Strategic Management Consulting. Prior to joining Delta Partners in 2010, Geoffrey worked at TPG Capital in Moscow, London and Paris. Prior to TPG, he worked at Security Capital Group, McKinsey & Company, Goldman Sachs and PaineWebber. Geoffrey received a J.D. from Harvard Law School, an M.A.L.D. from the Fletcher School of Law and Diplomacy and a B.A. from Yale University.

Michaël is an Associate at Delta Partners Capital with 11 years of experience in Private Equity, Strategic Management Consulting and the Consumer Goods Industry. Prior to joining Delta Partners Capital in 2010, Michaël worked for BCG in Brussels covering projects in Europe. Prior to joining BCG in 2006, he worked for Procter & Gamble. Michaël holds a Bachelor degree in Economics and a Master of Science in Electrical Engineering from the University of Leuven, Belgium. During his engineering degree, Michaël spent one year studying at the Ecole Polytechnique Fédérale de Lausanne, Switzerland.

William is an Associate at Delta Partners Capital with 3 years of Private Equity and Corporate Finance experience in Emerging Markets. He joined Delta Partners Capital in January 2014 and has been actively involved in the screening and execution of investment opportunities. Prior to joining Delta Partners Capital, William worked for HSBC in the Mergers & Acquisitions group covering the Middle East and North Africa. William has a Bachelors of Arts from Yale University, majoring in History (with an economics and business history focus).