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Emerging markets have rebounded as strongly as developed world markets, to the surprise of many. The engine has been Chinese stocks.

alexsl/iStockPhoto / Getty Images

Emerging markets may have enjoyed a strong start to the year, but they were sent tumbling in mid-March along with all world markets. Since then, they have rebounded nicely and look to be in a good position as recovery takes hold.

The swoon sent the MSCI Emerging Markets Index, the broadest measure of emerging economies, down 32 per cent. But emerging markets have bounced back since as strongly as developed-world markets to the surprise of many. The engine has been Chinese stocks, which make up 41 per cent of the index.

“Amid the sell-off, China was one of the few markets that really hung in there,” says Chris Heakes, director and portfolio manager at BMO Asset Management Inc. in Toronto. “It was seen to contain the virus and was the first to come out of it.”

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Specifically, he says the MSCI China Index is up by almost 23 per cent, in Canadian dollar terms, year to date as of mid-July. “That’s a strong return.”

Meanwhile, the MSCI Emerging Markets index is up by 1.8 per cent, in Canadian dollar terms, during the same period, outperforming the 6.1-per-cent decline in the S&P/TSX Composite Index.

While there are short-term challenges for emerging markets, their response to the pandemic is a function of maturing economies and institutions, says Christine Tan, portfolio manager and emerging-markets specialist at Sun Life Global Investments Inc. in Toronto.

“Most of these economies are big enough now that there’s a domestic cushion. They’re no longer toddlers, but teenagers,” she says.

The lessons learned and changes made following the 2008 global financial crisis are also helping these economies, Ms. Tan adds. Structural reforms strengthened central banks and beefed up stock-market regulators. As a result, they’re all better positioned to withstand shocks and implement appropriate policies. That’s one reason why the sell-off has been less severe than in other crises.

The long-term forces that have been carrying emerging markets forward are also still at work. These include urbanization and young populations with rising incomes. High savings rates mean there’s money to spend.

That offers opportunities for sectors such as consumer goods, e-commerce, banks, insurance companies and blossoming investment services. Health care infrastructure is another area of growth, particularly in China, which is facing a demographic curve skewed toward an aging population.

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The U.S.-China trade war will continue to simmer. Some manufacturing will move back to the U.S. and the sourcing of goods and supply chains will also change.

“Patience is required, but if you’re patient, you will be rewarded,” Mr. Heakes says. “Over the long-term, the outlook for emerging markets is good. It’s where growth is coming from.”

Both Mr. Heakes and Ms. Tan say that a basket of stocks is a preferred way to spread risk and capture well-capitalized emerging-market players. Ms. Tan says some of the themes include the many forms of online retail and as well as niches such as online gaming.

“In North America, we started with Visa and MasterCard and are gradually moving to mobile payments like Apple Pay,” she says. “But we don’t naturally adopt them because we started with credit cards. In emerging countries in sub-Sahara Africa and India, for example, once you go outside cities, people might not have bank accounts. But they do have a mobile phone, which they can use to easily transfer money or pay for things.”

That means emerging-markets technology companies play a different and more diversified role. She notes that China-based Alibaba Group Holdings Ltd. (BABA-N)‘s affiliate, And Financial, manages one of the biggest money market funds in the world on the strength of its e-commerce business, which has one billion users. By comparison, PayPal Holdings Inc. (PYPL-Q) has 325 million users globally and is predominantly an electronic payments business.

The impact of COVID-19 has also been uneven in emerging markets. China and South Korea were affected first but also emerged first. Ms. Tan says their experiences with other viruses and comfort with face masks have helped them cope with this outbreak.

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“[This year] is going to be a significant reset,” she says. “All these economies shut down for two to three months and some don’t have the same policy room that Canada, Europe and the U.S. have to stimulate.”

Mr. Heakes says India is struggling to contain COVID-19 and its markets have not rebounded as strongly. Brazil is also struggling, he says.

Both Mr. Heakes’ and Ms. Tan’s firms offer emerging-markets investment funds. BMO MSCI Emerging Markets Index (ZEM-T) is a passively managed exchange-traded fund with $1.8-billion in assets under management (AUM), weighted by market capitalization The top holdings by sector are technology, health care and telecommunications.

Sun Life Excel Emerging Markets Fund is an actively managed mutual fund that’s subadvised by Schroder Investment Management North America Inc. The top sectors are technology, consumer discretionary and financials. It has $510-million in AUM.

Mr. Heakes expects volatility ahead in emerging markets as the U.S. presidential election campaign heats up, ”but that doesn’t change those long-term drivers,” he says. “There will be bumps in the road, but a bumpy road doesn’t make it a bad one.”

Adam Mayers is a contributing editor to the Internet Wealth Builder investment newsletter.

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