Which Way for Emerging Markets in 2018?

Macro Fundamentals and Growth Drivers

• Emerging markets (EM) now account for 60% of global GDP growth, up from 50% a decade ago.
• EM houses 85% of the global population and is projected to drive 90% of both population and middle-class spending growth through 2030.
• The average age in developed markets is 46, compared to 26 in EM, where 1.7 million workers are added to the workforce monthly.
• By 2025, 413 cities are expected to fuel half of global GDP growth, and half of the world's $1B+ companies will be located in EM.
• In 2016, EM filed more patents than developing countries for the first time in history.
• Globally synchronized growth is occurring for the first time in a long time, with EM assets outperforming developed markets as the growth gap widens.

Country-Specific Dynamics and Policy

• China has stabilized with a "go-slow" approach to restructuring State-Owned Enterprise (SOE) debt, contrary to earlier bearish expectations of a hard landing.
• China's gradual de-emphasis on investment-led growth has stabilized commodity prices and halted capital flight from other EM economies that previously experienced outflows.
• Inflation has fallen in several EM nations (Brazil, Russia, South Africa, Colombia), leading to rate cuts and stabilizing inflation expectations in the debt market.
• Developed market debt is trading at negative or near-zero real yields, pushing investors to seek returns in EM fixed income.
• ABRAJ notes that China behaves differently from other EM markets regarding investment flows, acting as a unique ecosystem for capital raising rather than a proxy for the region.
• Africa has a median age of 18, presenting distinct dynamics compared to consumption-driven economies in South Asia or commodity-driven markets like Nigeria.
• Nigeria's economy is commodity-driven with regional literacy disparities, whereas Kenya is consumption-driven with higher overall literacy and business activity.

Investment Themes and Sector Opportunities

• Investment focus is shifting from macro commodity proxies to micro-level growth stories in consumer economies, healthcare, education, and financial services.
• Private equity and power sectors are moving toward renewable energy, with solar costs dropping from $9 million/MW (2009) to $0.80/MW (Mexico), undercutting coal projects.
• Per capita electricity usage in EM remains significantly lower than in developed markets, with demand expected to outstrip supply for decades.
• Private credit is identified as a high-risk-return opportunity, with credit penetration in EM (especially Latin America) being one-quarter to one-half of developed market levels.
• Public equity opportunities exist outside BRIC nations due to lower intra-country correlation (35%) compared to the broader EM index (70%).
• Blended finance is highlighted as a critical asset class, potentially unlocking trillions by combining private capital with government and foundation funding.
• ABRAJ targets specific sectors (healthcare, education, financial services, consumer goods) and emphasizes that micro-risk (management, governance) outweighs macro risk in success determination.

Market Structure, Flows, and Risks

• EM corporate bond markets have seen issuance increase 5x in five years while dealer liquidity capacity has fallen 80%, creating a potential "perfect storm" if dollar rates rise.
• Private equity flows are $22 billion in the first half of the year, but "zombie funds" with stuck capital in Brazil and India may delay economic revival by 1–3 years.
• OPIC (Overseas Private Investment Corporation) maintains a $23 billion portfolio focused on additionality, providing political risk insurance for projects like a gas plant in Ghana.
• Concerns exist regarding some Development Finance Institutions (DFIs) crowding out private capital by acting as arbiters of "winners and losers" rather than providing pure risk mitigation.
• Emerging market currencies have served as a safety valve during commodity downturns (e.g., ruble, real), but investors remain wary of depreciation risks.
• A lack of secondary markets for private equity in EM prevents the recycling of stuck capital, unlike in developed markets.
• Corporate external debt is projected to end the year near $1 trillion, while sovereign debt has grown from $5 trillion to nearly $12 trillion over a decade.

Future Outlook and Investor Sentiment

• The consensus suggests that policy mistakes, such as tightening monetary policy too quickly or geopolitical shocks, pose the most significant risks to the ongoing recovery.
• Digitalization and AI are identified as major disruption risks that could render half-billion-dollar investments obsolete within five years.
• Investors emphasize the need for "bottom-up" due diligence and the ability to distinguish between "good" and "bad" capital absorption in specific sectors and cities.
• Long-term investment horizons (10+ years) are required to navigate political cycles, currency shocks, and infrastructure development timelines.
• Scott Mackin notes that overcrowding and excessive AUM chasing deals in energy and infrastructure could lead to market distortion and a lack of discipline.