Finding high-calibre growth companies in emerging markets

All investment strategies have the potential for profit and loss, capital is at risk. Past performance is not a guide to future returns.

To succeed in emerging markets, you need to be adaptable and open-minded as to where growth might come from.

A Dutch economist gave the sector its name about 40 years ago after he was struck by the investment potential of some of the world’s fastest-developing countries. But a series of shocks – including the 1980s’ Latin American debt crisis, the 1990s’ Asian financial crisis and concerns about higher US interest rates in 2013 – have repeatedly driven investors to withdraw their capital, causing a pattern of boom-and-bust.

“Some investors will tell you that macroeconomics doesn’t matter and it’s all about just finding great companies and focusing on fundamentals, but I would respectfully tell you that it does matter in emerging markets,” says Will Sutcliffe, head of Baillie Gifford’s Emerging Markets Equities Team.

• Listen to the interview on Spotify and Apple Podcasts

Pick the right companies but at the wrong moment and currency moves coupled with stricter lending criteria can send the value of emerging market stocks and bonds into a tailspin. But, as Sutcliffe tells our Short Briefings on Long Term Thinking podcast, the results can be stellar when both factors work in your favour. And there are signs to suggest such a period is on the horizon.

“We’re still below the 2007 peak in the MSCI Emerging Markets Index at a time when other global stock markets have done well, and more capital has left emerging markets than flowed in for the best part of a decade,” Sutcliffe says.

The result is that asset prices appear undervalued when compared to other markets. But when you look to the state of the emerging markets’ economies, you find resilience rather than weakness.

“We’ve just been through the steepest rate hiking cycle in a generation, and many of the biggest emerging markets economies not only survived but thrived,” Sutcliffe says.

“We’re also seeing far more world-class companies coming through. The process started years back in South Korea and Taiwan, spread into China and now seems to be extending into India, parts of south-east Asia and Brazil.”

Computer chips and cheap deals

Sutcliffe draws on more than two decades of emerging markets investing experience to lead his team in identifying which companies qualify for that status. But there is no doubting the credentials of their largest holding. Taiwan Semiconductor Manufacturing Corporation, better known as TSMC, has close to a 60 per cent market share in manufacturing chips for third parties and counts Apple, NVIDIA and Qualcomm among its biggest clients.

“It's been in our portfolio since the 1990s,” says Sutcliffe. “When we first brought it, it was about twice the size of its nearest competitor, UMC [United Microelectronic Corporation]. Now, it’s about six times the size. It got there by doubling down every time there was a down cycle when its competitors retrenched.”

Despite having a market capitalisation of around 21tn TWD ($650bn), making TSMC one of the world’s top 10 most valuable listed firms, Sutcliffe believes it still has significant growth potential.

“Nobody knows what the new digital age will look like or which of the AI applications will be most successful, but we do have a good idea TSMC will be making the semiconductors powering them,” he adds. “And I think the market still misses how much value it could create in the decade ahead.”

In consumer brands, Sutcliffe gives PDD Holdings as an example of a domestic firm taking share from western rivals. The Emerging Markets Team originally invested in the company because of the growth prospects of its Chinese shopping platform, Pinduoduo. But the rise of Temu, PDD’s international offering, has radically exceeded expectations.

Temu’s app frequently ranks higher than Amazon and eBay in download charts and entices customers to make repeat purchases by offering special deals on the goods merchants list on its service.

“When we first took our investment at the start of 2023, we regarded Temu as having zero, potentially even negative, value,” says Sutcliffe. “But it’s become clear that the division alone is a very substantial part of PDD’s overall value.”

Cosmetics and credit

Natura is an even more recent purchase. A change of management and direction at the Brazilian beauty firm sparked interest. And Baillie Gifford’s Emerging Markets Growth Fund and Emerging Markets Large Companies Fund took stakes in March of this year.

“Natura lost its way over the past decade with a series of ‘di-worsifications’ – including purchasing Body Shop in the UK and Aesop in Australia – but it’s now reversed those and got back to its core Brazilian cosmetics business,” Sutcliffe says.

“It’s complex and messy, and the stock has been trading at a stupidly low multiple¹ as a result. But that’s the appeal from our perspective.”

By contrast, Indian companies with low price-to-earnings ratios are challenging to find. The country has many promising startups and its larger brands benefit from the public’s growing amount of disposable income, but Sutcliffe reflects that much of this potential is already reflected in valuations.

However, he highlights Jio Financial Services as an example of one company whose prospects were too bright to ignore, leading to his team purchasing shares for several funds last July.

“There are hundreds of fintech companies in India,” Sutcliffe says. “What makes this one special is that it’s backed by Reliance Industries and has access to all its data. We’re talking about 400 million telecoms customers and 200 million retail customers: that’s a very powerful combination.”

Energy transition

The Emerging Markets Team is also a longstanding shareholder in Reliance Industries itself. Despite diversification, the firm still makes most of its revenue from petrochemicals. Investing in a fossil fuel producer raises climate-related concerns, but Sutcliffe suggests selling out would be counterproductive to our clients and society.

“We do invest in carbon-intensive businesses,” he explains. “If we think they can manage the energy transition, then the most powerful thing we can do as long-term investors is to support them.

“Reliance is using the cash flows from its heavy-emitting, carbon-intensive petrochemical operation to create a telecoms network that is changing the lives of hundreds of millions of Indians, as well as investing billions of dollars into becoming India’s largest solar and battery company. It’s a complex issue, but backing that direction of travel is something we’re keen to do.”

Tilt to emerging markets

The performance of benchmark emerging market indices may have been lacklustre this past decade, but Sutcliffe suggests his team’s expertise in finding exceptional companies combined with more favourable macroeconomic conditions could make the next 10 years a very different prospect.

“If you think about the renewable transition, we're going to require an awful lot of critical minerals, including copper and nickel,” he says.

“If you think about developed market re-industrialisation, we’re going to need an awful lot of steel and cement. And if you think about AI, we’re going to need lots of semiconductors.

“So when I think about all those things, the idea that the world's centre of economic gravity will continue to tilt towards emerging markets seems very plausible.”

Words by Leo Kelion

[1] A reference to price-to-earnings – a financial ratio that measures a company's share price relative to its earnings per share.

Risk factors

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in March 2024 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

Potential for Profit and Loss

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

This communication contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research, but is classified as advertising under Art 68 of the Financial Services Act (‘FinSA’) and Baillie Gifford and its staff may have dealt in the investments concerned.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this communication are for illustrative purposes only.

Important information

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.

Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.

Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.

Financial Intermediaries

This communication is suitable for use of financial intermediaries. Financial intermediaries are solely responsible for any further distribution and Baillie Gifford takes no responsibility for the reliance on this document by any other person who did not receive this document directly from Baillie Gifford.

Europe

Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018. Baillie Gifford Investment Management (Europe) Limited is authorised by the Central Bank of Ireland as an AIFM under the AIFM Regulations and as a UCITS management company under the UCITS Regulation. Baillie Gifford Investment Management (Europe) Limited is also authorised in accordance with Regulation 7 of the AIFM Regulations, to provide management of portfolios of investments, including Individual Portfolio Management (‘IPM’) and Non-Core Services. Baillie Gifford Investment Management (Europe) Limited has been appointed as UCITS management company to the following UCITS umbrella company; Baillie Gifford Worldwide Funds plc. Through passporting it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Similarly, it has established Baillie Gifford Investment Management (Europe) Limited (Amsterdam Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in The Netherlands. Baillie Gifford Investment Management (Europe) Limited also has a representative office in Zurich, Switzerland pursuant to Art. 58 of the Federal Act on Financial Institutions (‘FinIA’). The representative office is authorised by the Swiss Financial Market Supervisory Authority (FINMA). The representative office does not constitute a branch and therefore does not have authority to commit Baillie Gifford Investment Management (Europe) Limited. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co. Baillie Gifford Overseas Limited and Baillie Gifford & Co are authorised and regulated in the UK by the Financial Conduct Authority.

Hong Kong

Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 and a Type 2 license from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of collective investment schemes to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 柏基亞洲(香港)有限公司 can be contacted at Suites 2713-2715, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. Telephone +852 3756 5700.

South Korea

Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.

Japan

Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.

Australia

Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth) and holds Foreign Australian Financial Services Licence
No 528911. This material is provided to you on the basis that you are a ‘wholesale client’ within the meaning of section 761G of the Corporations Act 2001 (Cth) (‘Corporations Act’). Please advise Baillie Gifford Overseas Limited immediately if you are not a wholesale client. In no circumstances may this material be made available to a ‘retail client’ within the meaning of section 761G of the Corporations Act.

This material contains general information only. It does not take into account any person’s objectives, financial situation or needs.

South Africa

Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.

North America

Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005 and is registered with the SEC. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in North America. Baillie Gifford Overseas Limited is registered with the SEC in the United States of America.

The Manager is not resident in Canada, its head office and principal place of business is in Edinburgh, Scotland. Baillie Gifford Overseas Limited is regulated in Canada as a portfolio manager and exempt market dealer with the Ontario Securities Commission (‘OSC’). Its portfolio manager licence is currently passported into Alberta, Quebec, Saskatchewan, Manitoba and Newfoundland & Labrador whereas the exempt market dealer licence is passported across all Canadian provinces and territories. Baillie Gifford International LLC is regulated by the OSC as an exempt market and its licence is passported across all Canadian provinces and territories. Baillie Gifford Investment Management (Europe) Limited (‘BGE’) relies on the International Investment Fund Manager Exemption in the provinces of Ontario and Quebec.

Israel

Baillie Gifford Overseas Limited is not licensed under Israel’s Regulation of Investment Advising, Investment Marketing and Portfolio Management Law, 5755-1995 (the Advice Law) and does not carry insurance pursuant to the Advice Law. This material is only intended for those categories of Israeli residents who are qualified clients listed on the First Addendum to the Advice Law.

101301 10046529