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Emerging markets were on fire in the first decade of this century before entering a period of underperformance as of 2011.Evan Buhler/The Canadian Press

It has been a decade to forget for emerging market investors, but if past history is a guide, now is the time to increase exposure to those parts of the world that appear poised for another run of explosive growth, top-performing portfolio managers say.

Emerging markets (EM) – which include countries like China and India with young, fast-urbanizing populations – were on fire in the first decade of this century before entering a period of underperformance as of 2011.

The investment thesis is straightforward for EM countries that represent about 60 per cent of global GDP; their economies are rapidly transforming from largely rural to more urban societies, with increasingly affluent consumers who are increasing their spending.

Investors can benefit from the growth of “the emerging markets consumer, financialization, digitalization, health and wellness, and green infrastructure,” says Phil Langham, London-based portfolio manager of the Lipper Awards-winning RBC Emerging Markets Equity fund in 2022 for 10-year performance.

The Series F version of the fund is down 15 per cent year to date, as of Nov. 8, after losing 5.6 per cent in the calendar year 2021. It made hefty gains in seven of the eight prior years. (All data from Morningstar). By comparison, its MSCI Emerging Markets Total Return Net Index benchmark is down 20.4 per cent this year and was down 3.4 per cent last year.

Mr. Langham also considers macro concerns such as currencies, political and economic risks when investing in EMs. It’s why he recently decided to shift some investments away from India and more toward China.

“China looks much more attractive from a valuation standpoint,” says Mr. Langham, who is RBC Global Asset Management’s senior portfolio manager and head of emerging market equities (U.K.)

The fund is also paying attention to the emerging market consumer, given the strong possibility of a global recession on the horizon.

Still, Mr. Langham argues that the themes driving emerging markets’ development are now so powerful that they will occur regardless of any economic slowdown. He says success for investors will come as these countries continue to improve their competitiveness and could see a boost from any decline in the value of the U.S. dollar.

“Generally, EM does better when the U.S. dollar is weak,” he says. “For EM to perform well, of all the factors that I can think of, the most important one would be a turn in the performance of the U.S. dollar.”

The U.S. buck has been one of the top-performing currencies in 2022, although some Latin American currencies “have held up pretty well.”

Investing in developing markets with an environmental, social and governance (ESG) approach can also pay off.

The Desjardins RI Emerging Markets Multi-Factor Low CO2 ETF won Lipper Awards recognition for three-year performance with an investment strategy that tends to favour smaller, more stable companies than the overall market, explains Pierre-Luc Vachon, senior advisor and team leader, products with Desjardins Global Asset Management (DGAM) in Montreal. Desjardins’ low-CO2 mandate acts to filter out the biggest carbon emitters by sector and country.

”We try not to take too many country bets with this strategy; the goal is to really make the factor and ESG work and not necessarily country bets,” says Mr. Vachon. His fund is down 14.82 per cent so far this year, as of Nov. 8 and returned 3.60 per cent in 2021. Its benchmark, the Scientific Beta Desjardins Emerging RI Low Carbon Multifactor Index, is down 14.3 per cent this year as of Nov. 8 and rose 4.7 per cent in 2021.

While the geopolitical environment appears grim today, Desjardins is optimistic about its future as an investment.

“Emerging markets are very cheap on a relative basis to developed markets, like they were in 2002,” says Jean-Pierre Couture, an economist and senior portfolio manager with DGAM. “Looking at valuations, it is the best in 20 years and despite all the narrative on the political side, there is no de-globalization. Global trade is increasing more rapidly than global GDP.”

The Montreal-based economist noted that China’s leader Xi Jinping acknowledged at the recent five-year Communist Party congress that the country needs to avoid the “middle-income trap” and would require foreign financing – and continued ties to the west – to accomplish that feat.

A final fact that could support an EM bounce back, he says, is that institutional investor holdings in emerging markets from the Western world are incredibly low, which suggests much of the bad news has already been priced in.

“Of course, if you wait until everything is clear for EM, you will miss most of the recovery in emerging markets,” Mr. Couture argues.

Still, EM can be unpredictable for even the most experienced investor. Each country is unique and can make sudden political or regulatory changes (such as China’s recent zero-COVID lockdowns).

EM is “a very challenging segment, but one that has a lot of potential over the long term as these companies, their consumers evolve, their GDP starts growing to significant levels,” says Terry Dimock, head portfolio manager with National Bank Investments.

“Also understanding the diversity of these countries, China and India are two of the bigger ones with very, very different dynamics and companies,” says the Montreal-based Mr. Dimock, whose firm won Lipper Awards recognition for its NBI Diversified Emerging Markets Equity Series fund for its three-year performance.

The fund is down more than 20 per cent year to date as of Nov. 8. It lost 6.5 per cent in 2021 and gained 36.5 per cent in 2020. By comparison, its MSCI Emerging Markets Total Return Net Index benchmark is down 20.4 per cent this year and was down 3.4 per cent in 2021.

The National Bank fund features sub-managers, including “big data” specialist Goldman Sachs Asset Management in New York and research-driven stock picker Newton Investment Management in the U.K.

“We felt the diversification of two managers, one which had more positions and was looking for singles and doubles and one with really deep fundamental information, really protected us on the downside,” he says.

“You want to avoid those pitfalls. Things change quickly [with] a less mature market, and corrections can definitely hurt significantly.”