Impact Blog

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Calvert disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Calvert are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Calvert fund. References to individual companies for Engagement or Research purposes are provided for illustrative purposes only and may not be representative of the results of all of Calvert’s engagement efforts. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Gary Greenberg, Portfolio Manager, Hermes Investment Management, Calvert Sub-Adviser

      London - The past five years have seen a dramatic shift in the strength and performance of emerging markets as many macroeconomic headwinds have turned into tailwinds. Indeed, many emerging-market countries have addressed historical current-account deficits, achieved a healthier balance between imports and exports, and are developing into economies driven by value-added industrial and knowledge-based output. In our view, many emerging markets look like they are on a path of sustainable, if no longer remarkable, rates of growth.

      As a result, we believe emerging markets are undergoing a secular transition from a destination for short-term trading with appeal determined by commodity cycles or currency swings, to a home for long-term investment capital. Furthermore, given their demographic, macroeconomic, and increasing political heft, emerging markets remain vastly underrepresented in investor portfolios as a proportion of global stock markets.

      Impact 3-5 chart 1

      We see a number of trends continuing to support emerging-market growth for the foreseeable future, including three key ones we discuss in detail below:

      • Corporate profit margins should continue to improve
      • Emerging-market GDP growth should stay strong relative to developed markets
      • Emerging-market currencies remain undervalued

      Room for greater profit-margin gains

      Across most emerging markets, net non-financial corporate profit margins have been recovering from a 5.5% trough in 2015 - nearly a two-decade low - to reach 6.7% in 2017. This is still below the 20-year average of 7.7% and far from the second-quarter 2008 peak of 10.5%.1

      In contrast, developed-market profit margins are near their 20-year peak. Only four emerging-market countries are approaching a similar level: Turkey, Indonesia, Hungary and South Korea. Margins in the technology sector, featuring outperformers such as Alibaba and Tencent, are near 10%, which is far below their 36% peak.2

      Growing corporate profit margins are driving an improvement in return on equity (RoE), and we expect further gains this year. Notably, emerging-market companies continue to trade at a substantial discount to developed markets on the basis of price-to-book valuations.

      Macroeconomic momentum

      Between mid-2010 and first-quarter 2016, GDP growth in emerging-market economies decelerated sharply, from 7% faster than developed markets to only 2.5% faster. According to forecasts, economic growth in emerging markets bottomed early last year and was followed by upward estimates for 2017 in total and for 2018. Indeed, emerging-market growth is picking up speed, and the International Monetary Fund forecasts a continuation of this trend.

      Impact 3-5 chart 2

      Emerging-market currencies are still undervalued

      In May 2013, at the height of the "taper tantrum," emerging markets were net borrowers and therefore vulnerable to U.S. monetary-policy tightening. Current accounts in Brazil, India, Indonesia, Turkey and South Africa were negative, and emerging markets together owed foreign creditors 1.1% of their combined GDP.

      The situation is different today. Emerging-market companies collectively are a net lender to foreigners (and the public sector) to the tune of 5.6% of emerging-world GDP.3 Brazil, India and Indonesia are running close to balanced current accounts - particularly when net foreign direct investment is added, achieving a basic balance for each - and the same is true for emerging markets as a whole.

      A long-term investment thesis

      The resurgence of emerging-market stocks is being driven by strong tailwinds: the macroeconomic environment is supportive, corporate margins are improving and valuations are still attractive. Meanwhile, currencies are less vulnerable to U.S. monetary-policy tightening. While it is always necessary for investors to exercise caution, we believe emerging markets are a universe where quality, value-adding and sustainable companies hold long-term promise.

      Bottom line: Emerging markets have pivoted from being net borrowers to lenders, with stronger economies supported more by intellectual capital than commodities and manufacturing. While on this path of sustainable growth, we believe emerging markets deserve strong consideration for long-term investment capital.