Emerging Markets Insights – A greener future

Three things we are thinking about today

1. Artificial Intelligence (AI) is driving increased chip demand. Semiconductor chip design company NVIDIA announced earnings in its fiscal second quarter are expected to surge 52% to US$11 billion on demand for its chips which support AI algorithms and large language models similar to Chat-GPT. The announcement drove the Philadelphia Semiconductor Index up 10%.¹ NVIDIA is a “fabless” chip company, meaning it designs chips, but does not manufacture them. The fabrication plants that do the manufacturing for such companies are mostly based in Asia and are direct beneficiaries of the surge in demand for chips that can support the coming AI revolution. This is expected to have a positive impact on the semiconductor ecosystem throughout Asia, ranging from chip manufacturers in Taiwan and South Korea to chip packaging companies in Malaysia, as well as those companies producing the chemicals and precision parts used in the lithographic machines that produce the chips from silicon wafers.
2. China cuts deposit rates. Chinese banks recently cut deposit rates to support bank profitability and ensure that loan targets are met. Net interest income contributes c. 70% of Chinese bank revenue,² and prior cuts in lending rates without corresponding cuts in deposit rates have put downward pressure on revenue. Deposit rates were cut 30-50 basis points for corporate and retail depositors. The rate cuts are expected to stimulate household consumption as well as support bank loan growth and return on equity. Unofficial targets of 10% loan growth and a 30% payout ratio amongst the “Big Four” Chinese banks imply the need for a return on equity of 10%-12%, which was at risk from the downward pressure on net interest margins. Maintaining credit growth is important for the economy given its dependence on bank credit, as opposed to other channels for recycling the large pool of household savings.
3. Emerging market fund flows. Following a lackluster start to the year, foreign investor flows to emerging market (EM) equities surged in May. Data from Lipper indicates US$2 billion in inflows between May 3-24, a positive signal. Equity fund flows to India were notable rising to a nine-month high in the month. The improved sentiment towards EMs may reflect the valuation gap relative to developed market equities as well as diverging growth expectations for the second half of 2023. Current consensus expectations call for the United States and Europe to enter a recession, but growth in emerging markets looks likely to remain resilient.

Outlook

We see a clear trajectory toward a greener future in EMs amidst country commitments to net zero³ and the emergence of climate-friendly technologies. Evidence of this lies in metrics related to the transition. For example, investments in solar power are expected to outpace investment in oil production in 2023.⁴ EM economies including India, Brazil and the United Arab Emirates have invested heavily in clean energy, district cooling and decarbonization.

We believe the transition to a greener future—a shift toward sustainable economic growth—is a megatrend that presents significant investment opportunities in environmental technologies related to renewable energy, decarbonization and electric vehicles (EVs).

We see beneficiaries of this green transition in companies that we invest in. The growth of the EV market, renewable energy and the increasing popularity of green construction methods and materials are some examples of this transition. Semiconductors also play an integral part, where they are used to convert and manage the transmission of energy. Within Asia, we see well-run market leaders in the upstream and downstream supply chains of EVs, solar equipment and construction materials poised to benefit from this trend. Outside of Asia, Brazil’s state-run oil company aims to focus on renewable energy projects, and the largest renewables producers in the Middle East have lifted capacity to new highs in 2022.

The ability to ready ourselves alongside these evolving trends stems from our focused investment approach, which enables our on-the-ground teams to identify business models and management teams that display agility and resilience in a fast-changing world. This local presence also helps us build local relationships and gives us the credibility to engage in effective long-term dialogue with management teams to generate better potential outcomes for all our stakeholders. We have built considerable expertise in the EM equity asset class, which we believe gives us the ability to identify investment opportunities before our peers.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. Investments in fast-growing industries like the technology and health care sectors (which have historically been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement or regulatory approval for new drugs and medical instruments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.

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1. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.

2. Source: FactSet.

3. Net zero is defined as cutting greenhouse gas emissions to as close to zero as possible, with any remaining emissions re-absorbed from the atmosphere, by oceans and forests for instance.

4. Source: International Energy Agency’s World Energy Investment 2023 Report.