Skandia UK - Emerging markets – the hotbed of innovation

Phil Reid looks at the opportunities for future growth in emerging markets.

Recent months have seen extreme volatility in financial markets across the globe. With undoubted signs of a slowdown in developed economies and sovereign debt concerns in the US and eurozone negatively impacting the performance of equity markets worldwide, the focus among investors has shifted firmly to emerging markets. In fact, the 21st century has largely been the story of how emerging markets have truly emerged from the shadows of the developed markets.

Today, emerging markets are undoubtedly driving the global economy. While developed economies look set to endure a lengthy period of lacklustre growth (or even contraction), fundamentals across the emerging markets look considerably healthier. Against this backdrop, the prospects for emerging market equities appear encouraging and, given their diversified nature, offer a wealth of opportunities for investors. So with these fundamentals in place, what about the companies themselves? Although the emerging market universe has many attractive prospects, there are an increasing number of outstanding companies in this hotbed of innovation that deserve closer inspection. In our opinion, investing in businesses well placed to benefit from the structural drivers in emerging markets (such as rising demand for resources and the emergence of a prosperous middle class in countries like India), offers the greatest potential. At HSBC, we have over 200 dedicated emerging market investment professionals searching for stocks like these. Two prime examples are Tata Motors and Vale.

Indian opportunity

Tata Motors (Tata) is India’s largest manufacturer of automobiles with an impressive track record and good profitability. This may not be a household name in the UK, but Tata is the third-largest commercial vehicles producer in the world. It also owns a well-known ‘British’ name – Jaguar Land Rover (JLR), which it bought in 2008. Despite the tough business conditions that followed, amid the credit crisis of that period, Tata’s management responded with prudent cost-cutting and innovative product development. The company has continued to cultivate the domestic marketplace in India by constantly introducing new products, including the very successful ‘1 lakh’ Tata Nano; which sells for only 100,000 rupees – about $2,000.

Tata also has ambitious plans beyond the cheaper end of the market. The purchase of JLR has opened up possibilities in the underpenetrated but fast-growing premium car market. While this high-end or ‘luxury’ segment is currently dominated by the developed world, the situation is changing rapidly, with JLR aggressively exploring new opportunities in China, Russia and Brazil, as well as its home market. In these countries, the premium segment has greater scope to expand than is the case in developed markets. With approximately £500 million in advance orders from over 20,000 customers for the company’s new flagship Range Rover Evoque, the future looks positive for Tata. We feel that it represents one of the most exciting investment opportunities in emerging markets.

In our opinion, investing in businesses well placed to benefit from the structural drivers in emerging markets ...offers the greatest potential.

Brazilian giant

Vale (also known as CVRD) is a Brazilian mining company that has expanded onsiderably in recent years. It is an emerging giant and already the largest producer of iron ore in the world, as well as one of the most profitable. The company stands to benefit from a powerful demand trend for iron ore: rapid urbanisation in China. Today, Europe has around 35 cities with a population in excess of 1 million. China already has in the region of 100, but, by 2025, this number is expected to more than double. The rise of cities like Shanghai and Beijing in the last 25 years exemplifies this phenomenon. Furthermore, Chinese steel consumption is following a previously seen pattern – that of significant expansion, with potential for further growth. This bodes well for mining companies such as Vale. We believe that Vale offers one of the most outstanding prospects in the emerging market universe.

Both companies exemplify a new type of business: an emerging market company looking to tap into growth in other emerging markets. With the developed world potentially facing a period of weak growth and the outlook for emerging markets seeming considerably more positive, companies such as Vale and Tata may well prove to be the way forward. At HSBC, our emerging market portfolios already have significant holdings in both companies. As such, we hope that the future is bright not just for emerging markets but also for our performance.

Phil Reid is Head of UK External Distribution at HSBC Global Asset Management.