Tech stocks such as the "FANGs" gain much attention but it may make more sense to consider those from emerging market economies, the author of this article argues.

With uncertainties around Europe and questions about US protectionism and high equity valuations, it is easy to see that emerging markets hold an allure. To explore the case for emerging markets – with some caveats – is Alex Brandreth, who is deputy chief investment officer of UK-based wealth management firm Brown Shipley. He also heads the third-party fund and structured product research at the firm. The editors of this publication are pleased to share these views; as ever they don’t necessarily endorse all views of guest writers and invite readers to respond. Email tom.burroughes@wealthbriefing.com
 

The main investment themes from 2017 have extended strongly into 2018. Despite a looming trade war between China and the US, there have been positive messages about the ongoing recovery of the global economy. While tariffs might spell short term weakness, there are upbeat activity indicators being recorded across both developed and developing economies signifying long term gain.

Growth stocks driving momentum

China’s influence on the world economy and investor risk sentiment remains powerful but significantly, the outlook remains positive. Equity markets in particular have recuperated from their slight tumble in February, with the driving force of “growth” stocks (which tend to reinvest earnings rather than pay dividends) behind them.

Over the last few months, tech-related stocks in particular have had an increasingly important role to play here and very much fit into this growth category. This theme leans strongly on the largely tech-focused emerging markets and US which have continued to outperform the Eurozone and the UK since last year.

Tech-led performance

Decades ago, equity exposure in emerging markets was dominated by industrials and commodity-related stocks, but now tech is an increasingly important part of both developed and developing economies.

By way of example, more than a quarter (26 per cent) of stocks in the US S&P 500 index are tech-related, a big share of which can be attributed to the well performing FANG group (Facebook, Apple, Netflix and Google). Similarly, the four largest companies in the MSCI Emerging Markets Index – Tencent, Samsung, Alibaba and TSMC (Taiwan Semiconductor Manufacturing) – are also tech-related giants, with their total weight reaching a lofty 16 per cent of the overall total of 28.7 per cent.

In contrast to the strength of the emerging markets, Europe’s main equity markets (both the UK and Eurozone) continue to struggle, not least because the MCI Europe and the FTSE 100 list a more diverse composition of stocks, with only 5% and 1% respectively related to tech.

Political uncertainty in the eurozone

However, political volatility across the region does not help either. Though the Italian government appears settled for the moment, a history of short-term parliaments makes it unclear how long this will be the case.

Elsewhere, with Spain due to switch government without holding another election, further instability for the eurozone might well be on the horizon in the next few months.

What’s more, the greater the political risk to the eurozone, the less generous the European Union is likely to be with respect to the terms of the UK’s departure from the bloc.

With all eyes now on the upcoming divorce settlement, investors will remain cautious about equity exposure in the region until October at the very least. If there is no clarity on where the UK and EU stand with each other, the situation is likely only going to worsen.

Emerging markets focus

As a result of this ongoing uncertainty, investment focus extends into the growing markets of less developed economies such as Latin America and Asia, the so-called “emerging markets”.

Of course, the risk for investors in these markets is higher than in developed economies, partly because their economic growth dynamic is less stable, and both political and structural economic foundations are less secure.

However, at the same time there are extremely powerful fundamentals working in favour of these economies which a more open, market embracing, global economic architecture is allowing to thrive.

Shifting demographics

Demographic factors, in particular, are especially powerful here – across the emerging markets landscape, a huge population is now rising into the middle class and driving growth in consumer spending.

For example, 88% of the next billion entrants into the middle class will live in Asia, whereas growth in the European and North American middle class is basically stagnating.  (1)

As such, a new age of tech is rising in the emerging markets from a consumer point of view, with previously untapped customers buying mobile phones and able to access Amazon and other online retailers increasingly so. (2)

Steer clear of the frontiers

The return potential of emerging markets is persuasive, but it is important to ensure that the risks associated with this exposure are lowered as much as possible.

A good, experienced third party fund manager will have in-depth knowledge of local companies and widely diversified funds across the market (often including both Latin American and South East Asian exposure), together with an excellent track record at delivering returns on a sustainable basis.

Overall, country specific exposure should be avoided, particularly to “frontier market” funds which invest in smaller, higher risk emerging markets. Often found in Africa, these markets are less mature and liquid, with higher volatility often caused by their exposure to banks.

“Tech boom”

The bottom line, as positive messages about the ongoing recovery of the global economy continue, is that investors looking to reap longer term benefits should shift their focus across the pond towards those less developed economies which are currently experiencing a “tech boom”.

The higher risks related to emerging markets hold the potential for high returns, but also mean that it is especially important to pay attention to portfolio risk management techniques that can lower risk as much as possible.

It’s not betting on tech that counts, it’s betting with a leaning on tech that will make all the difference.

Footnotes

Kharas, H. (2017) Global Economy and Development: The Unprecedented Expansion of the Global Middle Class

Barton, A. (2016) Amazon Eyes-up Emerging Markets for Next Growth Opportunity