Take outs

• Growing middle class in emerging markets creates new opportunities for investors
• Emerging markets will be a key global growth engine for decades to come
• A clear and early winner of the growing middle class is infrastructure

 

Amid collapsing bond yields and dropping interest rates, investors are being pushed to seek higher returns.

This growth will be driven by an expanding middle class and will spill over on spending and consumption patterns, which will have significant implications for global business opportunities and investment for decades to come.

In order to better understand the impending changes, Netwealth recently spoke to Sarah Shaw from 4D Infrastructure in a webinar entitled ‘Why emerging markets are too important to ignore’.

Sarah explains that the middle class is evidently growing every day in developing countries, invoking the need for a consideration of the investment opportunities this changing demographic is resulting in.

Individual perspective

Breaking down the implications of a growing middle class and considering it from an individual perspective, Sarah explains that as personal wealth increases individual consumption patterns inevitably change.

“This starts with a desire for three meals a day, moves to a demand for basic essential services such as clean water, indoor plumbing, gas for cooking, heating, power. This all requires infrastructure,” says Sarah.
And with power comes the demand for a fridge or a TV, which increases the need for port capacity and logistics chains.

It progresses over time to include services that support efficiency at a better quality of life, such as travel, with an increasing demand for quality roads and bigger airports to expand horizons. Importantly, Sarah says, one of the clear and early winners of this growth in the middle class is infrastructure, which is needed to support the evolution.

As such, the Global Infrastructure Hub predicts that by 2040 an additional US$94 trillion in infrastructure investment will be needed globally [1]. 

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Emerging markets to head global growth

According to Sarah, this impending growth calls for a direct focus on emerging markets.

“I truly believe that the emerging markets are just too important to continue to ignore in global allocations, as they offer an attractive risk-reward profile directly linked to domestic demand and the evolution of the middle class,” she underlines, adding that emerging economies will be a key global growth engine for decades to come.

But the complementary nature of emerging market economies growth and infrastructure investment goes even further.

According to Sarah, it offers investors access to the domestic demand story while mitigating some key emerging market investment risks, thus presenting a very attractive way to gain overall emerging market exposure.

“Let me just be clear. Risk is not confined to emerging markets, and to be honest, some key concerns of mine at the moment are coming from the developed world. We have Brexit, we’ve got Trump, we’re having problems in Italy, France, Hong Kong,” Sarah advises.

“However, if you focus in on the emerging markets, there are certain risks that can be mitigated by infrastructure investment.”

Tips to heed

Firstly, inflation.

A core concern for emerging markets over the medium term is domestic growth-driven inflationary spikes. However, Sarah explains that the infrastructure asset class provides investors access to the upside of the growth story, while explicitly hedging against inflationary pressure, with regulation and contracts providing an inflation hedge.

Secondly, beware of the benchmarks.

When looking for emerging market exposure, an investor needs to make sure they are actually getting emerging market exposure. Be wary of the constituents of the emerging market indices, says Sarah.
While some stocks are listed in a developing country, they may have underlying earnings drivers not correlated to the domestic growth, but rather global demand.

Thirdly, local governments are supportive of infrastructure development.

Emerging market governments and policy makers recognise the need for improved infrastructure to enable their economies to evolve.

As they cannot facilitate all the investment needed, they are supportive of private investment in infrastructure assets to provide the essential services needed to facilitate economic growth and deliver improved living standards. 

Sarah cautions, however, that while emerging market governments continue to need private sector capital, investors should have confidence that acceptable investment returns will be supported.

“When they no longer need your investment, they’ll tell you to get out. But that’s certainly not going to be in my lifetime, given the need for infrastructure capital today.”

Conclusion

When you put all these factors together, being the developed market replacement spend, population growth largely driven by the emerging markets, and the emergence of the middle class in emerging markets, the need for global infrastructure investment over coming decades is clear.

What is also clear is that the traditional providers of the infrastructure, i.e. governments, are simply not going to be able to fully fund this need; thereby creating this huge investment opportunity for the private sector over the coming years.

For more information on population growth and the rising need for infrastructure investment, listen to Netwealth’s webinar ‘Why emerging markets are too important to ignore’.

Find out more

For more advice on implementing a thorough investment selection process, listen to the Netwealth webinar, Learn how to navigate the changing equity landscape.

References:

1.  McKinsey & Company (October 2017). 'Bridging the infrastructure gaps, has the world changed?'.

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