Tariff twists and turns

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Things are changing rapidly. While markets are reassessing expectations for growth, inflation and the potential for a recession in the US, there are clearly numerous implications for the Emerging Markets universe. We must remind ourselves that any trade deals could have a finite life span and be ephemeral. We therefore need to be careful of being too ‘certain’ about any particular outcome and hold our convictions lightly. Our edge has always been an ability to put things into longer-term perspective. We could be witnessing quite profound shifts in global economic and political power.

So what have we been doing? 

Our first response is to have reviewed the portfolio with a distinct focus on areas of changing vulnerability to the direct impact of tariffs, as well as to companies more broadly at risk of a US recession and consequent global slowdown. We also want to keep our eyes open to where uncertainty and volatility may throw up opportunities for companies. 

Our starting point is a portfolio where the majority of China exposure is not directly exposed to trade. Over 85% of your portfolio’s China weight is in domestically focused companies or those that are in industries exempted from tariffs, with our attention going towards the small number of holdings earning a notable portion on their revenue from exports to the US that aren’t in exempted industries.

We should also remember that China has dealt with tariff threats for a number of years. Chinese exports to the US now contribute less than 3% of Chinese GDP, while at the same time, China is now the leading trade partner of over 120 countries, including eight of the top 10 economies in the world. It also has several tools available to mitigate the tariff threat, including further government stimulus, a potential tailwind for a number of companies in the portfolio. 

In India, the IT outsourcers are a key focus for us: a large portion of their revenues are linked to US spending, often discretionary. India perhaps becomes more interesting when seen in the light of its lack of goods exports. India is typically challenged for its lack of manufacturing export base within EM, but does this become a feature of resilience in a relative sense? Does a weaker dollar and a falling oil price help support a stronger view of India’s macroeconomic outlook? 

While the first order impacts of tariffs look relatively manageable, it is the secondary implications related to the risk of recession in the US and slowing global growth that concern us more. In this environment, entrenched competitive advantages matter more than ever. It is the companies with world leading products that both sides need, and countries with key resources, who stand the best chance of successfully walking the narrowing tightrope. Companies that are operating in large home markets, leading their industries, and that have business models without trade dependencies are likely to do well. These are the kinds of companies we like in our portfolios.

Questions about the impact of US-China decoupling are wide ranging and global in nature; this is not just about two countries. American withdrawal may light the touchpaper for greater intra-emerging markets trade in an increasingly multi-polar world. And that could be very important to EM investors. As of 2024, the US dollar made up only 57.4% of global foreign exchange reserves, down from over 70% in 2000.

The other side of this coin is that countries may increasingly be asked to ‘pick sides’ politically and economically. Does the ability for countries and companies to trade freely with ’both sides’ become compromised if this escalation continues? How does that alter the valuations foreign investors will be willing to pay for Chinese equities, as geopolitical uncertainty rises?

For all that we are excited about the domestic Chinese opportunity and the quality of the companies on offer – Deepseek may have just opened the eyes of the world to the levels of innovation and development in the country – China would be a larger part of our portfolios if it weren’t for geopolitics. 

As India, Vietnam and others seek negotiations to mitigate the tariff challenges, at the time of writing China is seemingly confident enough in its economic path to escalate tensions rather than lose face by being bullied into a deal. It clearly thinks it can withstand the inevitable deflationary pressures longer than the US can survive curtailed growth and persistent inflation, particularly given the challenges of an electoral cycle in the US that aren’t faced in China.

It should not be a surprise, therefore, to see that the delisting of Chinese American Depositary Receipts (ADRs) being raised again, adding further to the complexity of the situation. We should highlight this isn’t a new risk and we have significantly reduced exposure here by transferring holdings to the Hong-Kong line of stock in recent years, but it does reiterate concerns that politics may dominate economic fundamentals for periods of time. 

While uncertainty may be challenging in the short term, we shouldn’t be frightened of it. Periods of market dislocation throw up opportunities for stock pickers. A recent trip to Vietnam highlighted major economic and political shifts towards growth being supported by a focus on private sector and government reforms. And we now have a longer list of interesting names that we may get a chance to pick up cheaper as a result of the tariff twists and turns. 

Our key message is that we’re not making any knee jerk reactions in response to the situation. We’re sticking to our long-term growth philosophy and process which has worked over three decades of investing in EM. We are thinking about what the world may look like in years to come, and how that impacts the holdings in portfolios today. It may also throw up opportunities to invest in areas that we think are exciting over our investment horizons. Patience and perspective are important.

Risk Factors

This content contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.

As with all mutual funds, the value of an investment in the fund could decline, so you could lose money.

The Baillie Gifford Emerging Markets Equities Fund is distributed by Baillie Gifford Funds Services LLC. Baillie Gifford Funds Services LLC is registered as a broker-dealer with the SEC, a member of FINRA and is an affiliate of Baillie Gifford Overseas Limited. All information is sourced from Baillie Gifford & Co unless otherwise stated.

The most significant risks of an investment in the Baillie Gifford Emerging Markets Equities Fund are: Investment Style Risk, Growth Stock Risk, Emerging Markets Risk, Market Disruption and Geopolitical Risk and Government and Regulatory Risk. The Fund is managed on a bottom-up basis and stock selection is likely to be the main driver of investment returns. Returns are unlikely to track the movements of the benchmark. The prices of growth stocks can be based largely on expectations of future earnings and can decline significantly in reaction to negative news. The Fund focuses on investments in emerging markets, meaning it may offer less diversification and be more volatile than other funds. Investing in emerging markets can involve additional market, credit, currency, liquidity, legal or political risks than investing in more developed markets. The value of investments could be adversely affected by events such as war, public health crises and changes in economic and political conditions in the US and elsewhere. This could prevent the Fund from implementing its investment strategies and increase exposure to other risks. Governmental and regulatory authorities in the US and elsewhere have intervened in markets and may do so again in the future. The effects of these actions can be uncertain and could restrict the Fund in implementing its investment strategies. Some non-US markets have had little regulation which could increase risk of loss due to fraud or market failures. Governmental and regulatory authorities may adopt or change laws that could adversely impact the Fund. Other Fund risks include: Asia Risk, China Risk, Conflicts of Interest Risk, Currency Risk, Equity Securities Risk, Environmental, Social and Governance Risk, Focused Investment Risk, Frontier Markets Risk, Geographic Focus Risk, Information Technology Risk, Initial Public Offering Risk, Large-Capitalization Securities Risk, Liquidity Risk, Long-Term Investment Strategy Risk, Market Risk, Non-U.S. Investment Risk, Service Provider Risk, Settlement Risk, Small-and Medium-Capitalization Securities Risk, Underlying Funds Risk and Valuation Risk.

For more information about these and other risks of an investment in the Fund, see “Principal Investment Risks” and “Additional Investment Strategies” in the prospectus. The Baillie Gifford Emerging Markets Fund seeks capital appreciation. There can be no assurance that the Fund will achieve its investment objectives.