According to Thomas Wilson, who has been the head of emerging market equities at Schroders since August 2016, emerging markets is a heterogeneous universe with a selection of countries at different stages of economic development and with different drivers. It is therefore difficult to provide a short and simple answer to the question: what’s going on in emerging markets, or what is the outlook for emerging markets?
“If you want to simplify, you consider the four largest markets in the emerging market universe, China, India Taiwan and Korea, which constitute 80 per cent of the benchmark. Now, we’re active investors and the breadth of the EM universe presents opportunities for alpha generation. But the beta is effectively driven by four main markets: China, India, Taiwan and Korea,” he says and adds that these markets have very different drivers.
“India is your classic emerging market with low GDP per capita, low urbanization, favourable demographics and lower digital penetration and financial intermediation. This present opportunities for growth. If you look at Taiwan and Korea, they are much more mature and developed economies – Taiwan’s GDP per capita is USD 39 000 vs USD 2 900 for India. So, the drivers are different. Over 85 per cent of the Taiwanese market is tech hardware and TSMC accounts for more than half the benchmark. Korea is similar with over 60 per cent of the market in tech hardware, dominated by the two memory names, Samsung and Hynix. The tech cycle is a key driver for these markets. Then we have China, which has cyclical economic challenges due to the ongoing real estate bust, but has a broad and deep equity market which is ripe for stock picking,” he says.
Asked about how what drives performance, Thomas Wilson says that with some 80 per cent of the benchmark being constituted by four markets, it’s important that you deliver good stock selection within those markets.
“You need to be successful with your stock selection in those four markets, otherwise you’re going to have a problem. We’ve made money on the allocation to tech more recently as we’ve been overweight, but we’ve made far more money from how we’ve been positioned within the tech supply chain. If you take China as an example and look at Chinese earnings through time, they’re actually relatively unimpressive. But within China, you have an interesting and broad suite of stock opportunities. That’s where active management comes in. And it’s not just about stock selection, it’s also about managing geopolitical and political risk, macro risk, currency risk and so on. In short, it’s about generating alpha from stock selection but also generating alpha from the allocation you have to these markets and managing risk appropriately,” he says.
Asked if there are any markets that stand out beyond the four big ones, Thomas Wilson highlights emerging Europe where they’re typically overweight.
“Emerging Europe is interesting. It’s very simplistically an ongoing convergence story. Skilled labour remains very cost competitive relative to Western Europe. These markets are reasonably narrow, but you can still find interesting opportunities, not least in financials,” he says. The team is also overweight in Latin America and Thomas Wilson says that through time, they’re typically more overweight than not.
“Latin America has commodities, and strong commodity prices can provide a tailwind for economies and markets in the region. We’ve had a positive bias to copper for example, while our exposure to energy also typically is sourced in Latin America. However, as always there are differences between the countries. Brazil is a market which can cycle relatively aggressively and where one might manage the allocation more actively than in other markets. Trend growth is relatively low and concerns regarding fiscal sustainability makes political risk a key driver of market outcome via the yield curve, currency and sentiment. Mexico is an interesting market as a likely ongoing beneficiary of supply chain diversification. There are ongoing questions regarding the timing and mode of USMCA re-ratification, but Mexico should serve America’s strategic interest: it’s a low-cost manufacturing base on America’s border and America is insufficiently cost competitive to repatriate that manufacturing base.” he says.
Turning the conversation to what investors are currently focusing on and asking him about, Thomas Wilson says that it’s all about AI.
“The impact of the Iran conflict and how we are managing it is a key question. Investors have very little edge in predicting geopolitical outcomes, so our main effort is to understand relative sensitivities of different countries and manage exposure accordingly. We like to take risk where we have conviction so want to avoid taking material risk on geopolitics, while sizing countries, stocks and themes where we do have conviction. These more scaled exposures include tech, electrification, automation and defence and the underweight to India, which is a country that is exposed to higher energy and food prices, but where valuations remain relatively expensive,” he says.
He adds: “Equally if not more important is duration of the tech cycle. We have a very strong cycle, but how long is it going to last? Our conviction from a top-down perspective has strengthened as we’ve gone through the last six months. Model capability has been surprising positively and we believe that commercial use cases are proving up. Inference demand is growing very strongly and there is a shortage of compute. So, from a top-down perspective, our conviction that the demand is there has been reinforced. Earnings momentum is very strong and we are overweight. However, from a bottom-up perspective, valuations have lifted materially and one must manage selection and risk carefully.”
He says that investors are also asking about Brazil, where they’re overweight and where there are elections in October of this year.
“You will likely see a binary market outcome depending on whether Lula wins or whether a right-wing candidate, most likely Flavio Bolsonaro, wins. A right-wing candidate with a credible finance minister can have a significant impact on the yield curve, currency, business confidence, equity allocations and valuation multiples. People are also asking about China and US trade relationship, but we believe risk here continues to be anchored by China’s leverage in rare earth. Chin’s economy is also an ongoing source of debate. Exports are growing strongly and we are overweight Chinese industrials, which are highly cost and product competitive and have the opportunity to grow export market share. An ongoing question is when we might get a stronger domestic economic tailwind. The headwind here is ongoing stress in real estate, which drives a negative wealth effect given it has been the dominant destination for Chinese household savings. This suppresses household confidence, pushes up precautionary saving and depresses consumption. Eventually, real estate will stabilise which may create space for a sustained recovery in household confidence and an easing in precautionary saving. But we just don’t see that happening soon,” he says.
Thomas Wilson adds that India is often another topic. India performed well from 2021 to Q3 2024, as earnings recovered well post-Covid and rising domestic equity participation pushed valuations to very elevated levels.
“Since then, it has underperformed markedly. Equity issuance rose strongly to meet the increased domestic flow into equities. Meanwhile, India saw a slowdown in nominal growth and negative earnings revisions challenged elevated earnings multiples. Finally, the emergence of a very powerful tech cycle took investor focus elsewhere. The question for India now is, at what point is it interesting? We see two reasons. One is that you see a re-acceleration in nominal growth and frustratingly, if it weren’t for the Iran conflict, you would likely have seen that this year. The other is that India will perform if IT rolls over – India is an anti-AI trade,” he says.
Referring to their process and philosophy, Thomas Wilson says that he has a team of more than 30 fund managers and analysts managing over USD 50 billion in emerging market equities.
“We have significant resource, which we can leverage to address the breadth of universe,” he says. He adds that with regards to the philosophy, they focus on three key things.
“First, there’s substantial dispersion between markets as well as within markets, so we look to generate alpha both from country allocation and from stock selection. Secondly, we’re style agnostic. We don’t like to constrain ourselves stylistically. Thirdly, as a function of looking to generate alpha both from country and from stock and being style agnostic, we should have good dispersion of risk across opportunities and hope to deliver a good risk adjusted outcome,” he says.
He continues: “With regard to our process, we have a three-stage process: stage one, allocate to country; stage two, build country sleeves; stage three, confirm the shape of the overall portfolio. The confirmation phase involves confirming sector and industry exposure, risk metrics at the aggregate portfolio level and each stock’s active load and risk budget, to ensure we have a balanced and integrated portfolio”. Asked about what keeps him attracted to emerging markets, Thomas Wilson highlights the diversity. “This can be challenging because there’s always a lot of ground to cover, but it’s endlessly stimulating. It’s great fun and I love it,” he says.
