Comment on Q4 2020: Very strong finish and outlook for emerging market equities

With 2020 now concluded, and reviewing all that happened during just this twelve-month period, it is fair to say that this has been a remarkable year, if not a tragic one. And while the pandemic’s cost on society has been very high, it did result in some positive changes. In particular, sustainability finally got its well-deserved focus, as governments identified green spending as a way to drive the recovery, many companies placed ESG higher up on their strategic agenda, investors increased their allocation to ESG funds, and citizens all over the world discovered new ways of consuming and socially interacting that are less carbon intensive.

For us at East Capital, it was very interesting to see that the travel restrictions did not result in fewer interactions or engagements with our portfolio companies, but rather we “stayed local,” in virtual meeting rooms, instead of physical ones, and company management made themselves much more available for investors. The crisis has also shown what incredible feats can be achieved, with multiple Covid vaccines developed in less than a year, compared to the normal average of more than 10 years. We now expect to see a broad vaccine rollout in 2021, though populations in advanced economies will probably get them first. For emerging markets however, they have the benefit of generally much younger populations, which means less doses will be required to help those most at risk.

Somewhat surprisingly, the year turned out to be a good stock market year, as quick and unprecedentedly-large interventions by governments and central banks boosted demand for risky assets. This was especially visible in the IPO markets, where 2020 saw a volume of around twice the previous peak seen in 2014, with strong post-listing rallies for companies with resilient business models. As examples from just Eastern Europe, we had three e-commerce and fintech players going public during the last four months of the year (Russia’s Ozon, Poland’s Allegro and Kazakhstan’s Kaspi), and all were up an astonishing 50% to 100% at year-end.

For broad markets and the full year, MSCI Emerging Markets gained 17.7%, ahead of MSCI Developed Markets, which was up 16%, while MSCI Frontier Markets lagged and gained 1.3%. But while broad markets recovered well, some regions did better than others. Among our funds, those with Asia exposure showed stellar performance, with East Capital China A up 36%, and East Capital Global Emerging Markets up 33.5%, while Eastern Europe-exposed strategies lagged, with East Capital Russia down 0.9% and East Capital Eastern Europe down 11.2%.

Strong finish to the year

The final quarter offered a very strong finish for equities, with MSCI EM up 19.5%, MSCI FM gaining 10.7% and MSCI DM up 13.8%. All of our key markets showed positive returns, and previous quarter’s laggards, Brazil, Greece and Turkey, were the strongest, gaining 37.1%, 36% and 35.2% respectively. We had two key drivers during the period. The first was positive vaccine news. While a vaccine was largely anticipated by markets, the timeliness and effectiveness of the announced vaccines surprised on the upside and caused expectations of a quicker return to normality, and this in turn supported value stocks that are mainly prevalent in traditional industries. This factor had a positive impact, especially on our holdings in Eastern Europe and the Balkans. The second driver was the US election outcome, as Democrat Joe Biden’s win was taken very positively by the market. The appointment of the new US administration is, in our view, supportive for Emerging Markets and the companies we invest in, as it will result in a more orderly discussion on the geopolitical scene, less focus on trade wars and more focus on sustainability and climate change.

Outlook for 2021

For the coming year we are very positive. We recently published our outlook for 2021, and it was probably our most bullish outlook in many years. We see a good chance that emerging and frontier markets will outperform, thanks to six main reasons:

1. Highest global economic growth for 44 years (up to 6% GDP), as vaccines bring mobility and consumption roaring back.
2. Ultra-low interest rates in developed markets and a new normal of lower rates for emerging markets, which will push investors into equities, boost valuations and drive the continued flow of retail investors into markets.
3. Biden in the White House, which removes a significant number of tail risks, meaning a lower equity risk premium globally, especially in emerging markets.
4. Massive monetary and fiscal stimulus, with central banks’ balance sheets expanding by 29% of GDP in 2020-2022, versus 7% of GDP during the Global Financial Crisis.
5. Softening USD, as US real rates move further into negative territory due to the FED’s average inflation targeting, and net FDI flows into the US turn from positive to negative.
6. Superior earnings growth (2021 EPS growth of 33% in emerging markets, compared to 20% for S&P 500), but 32% discount on S&P 500 on P/E multiples.

And while there are always known and unknown risks on the horizon, we do note that we are not alone in our positive view on the asset class. Respondents of Bank of America’s Fund Manager Survey in December now cite the highest allocation to emerging market equities since 2010, and a full 60% of them expect emerging markets to outperform in 2021.

A sustainable focus

Sustainable investing and a strong ESG focus have long been a core part of East Capital’s Investment Philosophy and Process, not only in terms of identifying risks, but also to find opportunities and contribute to the advancement of sustainability in our investment universe. Thus, with 2020 proving an inflection point for the topic, we expect this theme to be a value driver for many of our investments over the coming decade. Our full integration of ESG into our investment analysis gives us a lot of insights when assessing investment cases across emerging and frontier markets, and helps us identify engagement priorities. Our long-term perspectives and close relations with the management teams of our portfolio holdings will enable us to reach our goals and contribute to relative and absolute performance.