26 Nov 2020
Will Scholes, Investment Director, Aberdeen Standard Investments
The whole world is feeling the effects of Covid-19 and will do so for some time to come. But just as the coronavirus cripples some immune systems, and leaves others unscathed, the financial impact of containment measures will leave some better off and others destitute.
The International Labour Organization (ILO) anticipates that a pandemic-induced drop in global gross domestic product could make an extra 25 million people unemployed. The ILO also fears that up to 1.6 billion of those in the informal sector could lose their jobs. A lot of these people work in the gig economy and many will have no access to social protection.
Each country’s resilience to the pandemic correlates strongly with its capacity to intervene financially, but also with its:
It is clear that the toll Covid-19 exacts in emerging market countries will be particularly brutal. The United Nations’ Sustainable Development Goals (SDGs) address many of these pillars of basic social and technological infrastructure directly. The world’s progress towards these targets has been sluggish, however. And, according to the UN’s July report, the Sustainable Development Outlook 2020, Covid-19 has slowed it even further.
In certain cases, limitations on face-to-face interactions directly hinder education and healthcare. These rules can even halt sales of basic insurance products or microfinance-loan provision. Small businesses will bear the brunt of the business interruption, with little in the way of working capital, and restricted access to funding.
Equally, domestic issues are preoccupying much of the developed world. This means the capital call to fund the SDGs – which are not exclusive to emerging markets, just particularly relevant there – is growing fainter. A common perception that investment in line with the SDGs is largely philanthropic in nature unfairly restricts the pool of capital available. In real life, the SDGs align closely with local policy (current, but especially future) and tap into large pools of latent demand.
Often, these impactful activities are hidden in plain sight, being core lines of business, not indirect philanthropy.
Indeed, this is what makes emerging markets so fertile for stock-pickers seeking a dual – financial and social – return.
During the height of the pandemic, many emerging market countries were unable, or in some cases unwilling, to meet the virus with monetary and fiscal action. In this way, they stood clearly apart from their developed peers. It would be wrong to suppose that massive stimulus and support measures of the kind seen in developed markets were the right tools for the rest of the world in any case. To be successful, such moves require efficient and targeted delivery. They also rely on the surety that rampant inflation and currency devaluation following large-scale borrowing will not cut today’s lifeline tomorrow.
By specifically undermining small businesses, however, the coronavirus risks widening the productivity gap that has opened between developed and emerging markets. There is a clear link between attaining the SDGs that target such businesses and the potential for collective economic gain.
In its recent report on global productivity, the World Bank says that capital deepening (an increase in the capital-to-labour ratio) is at the heart of the emerging market productivity gap. To view the issue simply, there are two things letting emerging markets down: operating efficiency, and the quality of the funding base. Over the long run, there are clear links between the two.
Long-term investors seek qualities such as currency and regulatory stability, and prudent policy. Emerging markets have always struggled to withstand the volatility caused by ebb and flow of foreign capital, and the size of that tide relative to domestic funds. Typically this manifests itself as currency depreciation. More recently, low interest rates, expansive fiscal policy, and higher savings rates caused by Covid-19 lockdowns may have started to redress that balance. Individual participation in equity markets has increased dramatically.
Markets like Russia and Brazil provide clear examples of this trend. Individual accounts on the Moscow Exchange have increased from 2 million in 2018, to 6.8 million at the end of September 2020. They represent more than 40% of traded volume on the exchange. Similarly, retail accounts on Brazil’s Bovespa have climbed 118% over the past year. Domestic bond markets, too, are strengthening – not least in China. Piecemeal local asset allocation trends in favour of equities are helping to bring down the costs of capital.
Relying on the drug of short-term funding is a destructive addiction. We see this at its most acute in petro-economies. In Russia, there is now a shift to embed more prudent fiscal policy. This means, at times of higher prices, saving a portion of oil revenues to provide support when prices are low. Such a shift reflects that Russia has deeper concerns than the simple need to smooth the oil cycle. Economies where resource industries dominate are cyclical. Fluctuations can snuff out the small and medium-sized (SMEs) enterprises that are needed to foster entrepreneurship. It is no surprise that cyclical factors act as a greater drag on productivity in commodity exporters than other countries. Warranting equal attention, however, are the second-order effects. These include a loss of innovation and the deterrence of long term capital.
Source: The World Bank
Globalisation has peaked. Trade disputes, failing respect for intellectual property, and lately travel restrictions have all helped bring about this change, but the knock on effects need not be entirely negative. Digitalisation trends have received a major boost. From a sustainability perspective, the outcome is likely positive in the long run. The US is beginning a fresh chapter under a new President, following an administration known for erecting barriers to trade and movement of people. It is fitting, therefore, that 15 nations have just signed the Asia Pacific Regional Comprehensive Economic Partnership, with the potential to add $200 billion in trade by 2030. Capital needs have no nationality and financial markets remain largely borderless. It is time to approach sustainable investing in emerging markets with a similar sense of renewal.
Brazil’s labour productivity levels have decoupled from those of the OECD area over the past 15 years. Based on company size, productivity gaps between SMEs and larger corporates are more pronounced in Brazil than the OECD average. While developed economies have embraced online sales, internet penetration of businesses within Brazil remains relatively low, at just over 50%. In comparison, the UK has penetration closer to 90%.
Mercado Libre is an e-commerce company operating across 18 Latin American countries, acting as a marketplace for buyers and sellers to transact. An enabler of small business, SMEs account for 61% of gross merchandise value sold through the MercadoLibre marketplace. Through MercadoLibre, SMEs can reach new clientele beyond their immediate locale, presenting new growth avenues and provide more efficient information for future capital allocation.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance. Capital at risk.
Risk warning
The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.