Posted inEmerging Markets

How digital disruption modernised the EM investment case

Global emerging markets have changed dramatically in the last 10 years; and, as a result, their traditional investment case, heavily centred on physical resources and cheap labour, is no longer valid, writes Alistair Reynolds, portfolio manager at Martin Currie.

These nations have instead shifted towards the service industry, leading to widespread changes within many of the subsectors. Drivers of this trend include structural changes, demographics, greater affluence and swathes of Stem graduates, enabling emerging markets to nurture some truly world-leading IP companies which form a key part of the global economy.

As emerging markets rapidly innovate, the opportunity set for investing is now broad and varied.

Looking back 10 years ago, many global emerging market investments were in the energy and financial sectors. Today, the balance has materially shifted, with IT now a top runner, followed by consumer.

Future of financials

The digitisation of emerging regions has infiltrated all segments of the market. From a technology standpoint, we saw the creation of a new breed of internet-based giants and the rise of emerging market technology companies to become global leaders.

More recently, there has been an increased focus on responsible investing with asset owners, investors and corporate management teams all working to improve outcomes across a range of ESG topics, which requires access to data and enhanced technology. Finally, the continued rise of China has further influenced the push for digitisation.

Looking specifically at digitised subsectors, there has been widespread evolution of financial companies and the products they offer. Ten years ago, the financial sector mainly consisted of local banks.

Now, it covers a broad range of services and companies, such as leading providers of microfinance in Indonesia and South America, digital IP-leading banks in Russia and India, as well as Chinese insurance. Digital disruption has blurred sector lines, allowing emerging markets to develop much of the best financial sector IP in the world.

Unlike 10 years ago, digital is the front and centre of analysis for financial companies, rather than simply an agenda item. Financials have embraced technology and technology firms have competed with more traditional financials – mobile banking apps enabling penetration into underbanked areas or payment apps integrated with leisure apps are two examples.

As technology businesses grow, we expect future big tech to eat into the profits of the traditional financial sector. Financials need to innovate and embrace technology to compete with the new economy businesses which present a hybrid of financials and technology.

Investment case for a digital emerging world

Some truly innovative new economy emerging market financial firms have attempted to reshape their businesses to embrace these megatrends rather than combat them. For example, HDFC Bank, a leading retail bank in India, has truly embraced technology. HDFC benefits from reaching underbanked regions and prioritising its lending to key sectors including micro businesses, education, housing, infrastructure and renewable energy.

The company places deep importance on its digital efforts, and its digital strength helps to enable it to reach unbanked areas – a rural farmer is much more likely to have a smartphone than access to a bank branch.

Another example is TCS Group in Russia, which is world leading in digital financial services. It is a new breed of digital bank, preserving an entrepreneurial, technology culture rather than a financial one: staff have an average age of 27, half work remotely, strict net present value (NPV) overlay on every piece of business. Its 30- 40% return-on-equity in an underpenetrated market makes it one of the most profitable financial or fintech or technology companies in the world.

Despite their differences, both TCS and HDFC have a clear digital strategy, investing in their technological infrastructure and further blurring the lines between technology and financial firms.

Looking forward

Looking ahead to the next 10 years, we expect to see the growing affluence and consumerism in southeast Asia. Technology has already begun to accelerate the shift, not only because of greater accessibility but also, contributing to a broadening the range of services available.

The roughly 668 million consumers in the region are rising in number and are composed of young populations with a high propensity to use digital solutions. This has already been witnessed in the rise of internet businesses where some apps are almost a one-stop-shop for the average young consumer’s every need: instant messaging, social media, e-commerce, gaming, mobile payments etc.

It is no wonder, then, that the competition within and evolution of the space and the demographic will create more opportunities for innovation.

This article was written for Expert Investor by Alistair Reynolds, portfolio manager at Martin Currie.

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