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Emerging markets are soaring off the back of the COVID-19 recovery, but there are a few consumer trends that are here to stay.
One trend is a cut above the rest. Emerging markets have reached a point of discerning tastes and a hunt for quality. Consumers in emerging markets are starting to seek higher levels of after-sales service, a trusted brand and product provenance. This behaviour will transform the emerging market sector from a numbers game to a function of price. It also shows the elasticity of the market and looks toward being able to absorb inflationary pulses.
“What you will see is that market growth is a function of volumes, so penetration of units, and a function of price. Price – we think of as price rises, but really it’s premiumisation,” said Duffy.
“In the case of home appliances, it’s taking a very basic rice cooker, or oven hob and turning it into a smart cooker or a smart hob, or a smart refrigerator. So those sorts of shifts are ongoing,” he said.
Data and marketing research house Nielsen defines premiumisation as “goods that cost at least 20% more than the average price for the category”. Twenty per cent more. Imagine if inflation was running at 20% – there’d be blood in the streets. Yet, the premiumisation trend is taking off in emerging markets and shows no signs of slowing down.
The growing middle class in China, India and other parts of Asia has created huge market opportunities for investors. Perhaps counter-intuitively, the pandemic has only accelerated this trend. While you may think that the economic slowdown from 2020 may linger, experts are more inclined to think that the pent-up demand, forced savings and additional stimulus from pandemic relief is actually going to perpetuate the trend of the premium consumer.
In part, it’s a result of the rising middle class in China – a trend that has been unfolding for at least a couple of decades. But while some parts of the country remain tied to the developing market thematic, other regions are chasing higher quality goods.
“In the same way that we said that not all emerging market countries are equal, not all provinces in China are equal. It is a vast market,” said Duffy.
Premiumisation of soy sauce
Soy sauce is not a product that immediately comes to mind as a premium product. Therein lies the opportunity. In his video below, Duffy outlined a few examples of how this premiumisation is playing out in emerging markets.
Foshun Haitian (SHA: 603288) is a stock that Fidelity has held for a long time, Duffy told us. They produce soy sauce as part of a range of condiments, sauces and flavourings for the Chinese market.
“What COVID actually did is that, despite the pressure that came on the restaurant channel as a consequence of closures, it made consumers far more aware of product provenance and brand quality,” said Duffy.
“So the actual ingredients and the sourcing, and the heritage of soy sauce as a product became even more important than it had been previously,” he said.
But the concept can also be rolled out across technological innovation as a premiumisation of existing products, such as the aforementioned rice cookers.
“It’ll become a shift of less volume, less consumption of units per capita, but the units that are being consumed are high price point, and then ultimately probably more value add to the companies that can execute on that,” said Duffy.
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Investors keen to see whether China’s bull market can keep charging ahead in the lunar Year of the Ox will be focused on the sustainability of economic recovery and the pace of possible monetary tightening.
China’s modern stock markets are only three decades young, but the Year of the Ox (or Bull) has so far managed to live up to its name for investors.
The last lunar Year of the Ox, in 2009-2010, brought a 51 per cent surge in the benchmark Shanghai Composite Index. The cycle before that, in 1997-1998, witnessed a 27 per cent rally.
Of course, past performance is not a reliable indicator of future results. But as the new ox year kicks off on Feb. 12, several factors will be front of mind for investors eyeing China’s markets. First and foremost is that ample liquidity and China’s “first in, first out” recovery from the economic fallout of the global Covid-19 pandemic look set to help sustain bullish market sentiment into the spring, in both the onshore market and Hong Kong. But any flare up in inflationary pressures or sharp turn to monetary tightening could threaten to put a yoke on hard-charging markets.
The recovery continues
Like in 2009, investors today have been emboldened by cheap credit and a strong post-crisis economic rebound. The macro backdrop helps: China’s was the only major economy with positive growth in 2020, and consensus forecasts for this year project GDP rising about 8 per cent. Analysts also expect robust earnings growth for Chinese companies at least in the first two quarters.
In March, China’s legislature, the National People’s Congress, is expected to unveil details of the country’s 14th five-year plan, which will set the high-level growth and development agenda through 2025. This year is also notable as July will mark the 100th anniversary of the establishment of China’s ruling Communist Party, and maintaining social stability and economic strength are paramount goals. Chinese policymakers’ stated aim of achieving a “moderately prosperous society in all respects” means sparing no effort to support growth while minimising systemic risks.
But investors should also be watchful for high volatility and sharp divergence in performance between sectors. In our view, some valuations already look stretched in sectors like technology, consumer and healthcare, where more crowded trades may result in wider price swings. On the other hand, many large financial stocks remain laggards, trading at single-digit earnings multiples or discounts to book value.
Unlike the broad-based bull run in 2009, structural growth themes will likely reign this year, with certain hot sectors and industry leaders dominating the show. Domestic consumption should continue to shine, as Chinese policymakers seek to boost internal demand in the face of ongoing trade tensions with Washington.
Consumers may take the baton from exporters who played a key role in China’s recovery last year. The job market has stabilized with unemployment falling back to pre-pandemic levels, while large savings pots allow the release of more spending power – China has one of the highest savings rates among major economies. Last year, facing the uncertainties of the virus threat, China’s consumers saved even more by cutting back on travel and other discretionary spending, but the rollout of vaccines and continued recovery may allow them to loosen their purse strings once again.
Inflows to Chinese equities have been on a steady rise in recent months, as foreign investors seek exposure to the renminbi’s appreciation as well as China’s economic growth. Investors may also be rotating out of the domestic property market, where the government has imposed tough measures to curb speculation. Recent IPOs of Chinese companies, especially in Hong Kong, have been strong.
Still, there is no way to know how far the 2021 bull can run. We see more cause for caution in sectors where valuation multiples have rapidly ballooned. One key risk is faster-than-expected policy tightening. As the recovery continues and inflationary pressure builds up, China may become the first country to need to mop up liquidity.
So far this year, the People’s Bank of China has been sending out mixed signals, draining funds at times to test market reaction. Concerns over tightening caused market jitters in late January. There may yet be more small tightening steps to cool inflation or limit asset bubbles. Nevertheless, we expect any further normalization of monetary policy to be slow and gradual, as the central bank takes care to maintain market stability in what China hopes will be an otherwise auspicious year.
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By Jenn-Hui Tan
Global Head of Stewardship and Sustainable Investing
Sustainable investing identifies themes that will grow in importance based on our needs as human beings. We need a stable climate to survive and, to achieve that and thrive, we need a more balanced society. That means narrowing social divides where possible, including ensuring equitable access to the internet as the world shifts online.
Below we examine how Fidelity International plans to engage with three of these crucial themes in 2021 and beyond: climate and natural capital, employee welfare and digital ethics.
1. Understanding nature-based risks as part of tackling climate change
Climate change is the critical issue of our time. Without the rapid reduction of carbon emissions, it will become increasingly difficult, if not impossible, to avoid catastrophic climate effects that radically alter our way of life. The financial impact alone will be immense. A report by the Carbon Disclosure Project and University College London estimates that if nothing is done to reduce emissions, the costs of climate-related damage will climb to €31 trillion per year by 2200. But the impact on humanity will be so devastating by then that the cost will be irrelevant.
Fidelity International seeks to decarbonise in several ways. First as an asset manager through our proprietary sustainability ratings. We use these to identify companies exposed to climate risk, whether physically or from increased regulation. We then engage with those firms on managing that risk and reducing direct and indirect emissions. Second, we participate in global programmes such as the Climate 100+ initiative that pushes large emitters towards more sustainable business models. And third, we have set our own corporate target to achieve net zero carbon emissions across the company by 2040. We also recently committed to the Net Zero Asset Manager initiative, which supports investing that is aligned with net zero emissions by or before 2050.
In 2021, we will increase our efforts to understand the risks posed by the loss of natural capital. The Covid-19 pandemic may have been triggered by human expansion into natural habitats, which brings home the impact of nature loss on us. Half of the world’s GDP (c. US$44 trillion) is “moderately or highly linked” to the availability of natural capital, according to the World Economic Forum; so any loss is environmentally and financially damaging. Moreover, the potential negative feedback loops between climate change and nature loss (for example, via deforestation) make the erosion of natural capital a systemic risk for investors and society alike.
Better data and more policy action
Calculating and then pricing greenhouse gas (GHG) emissions still presents challenges, but the quality and availability of information are improving steadily. We expect the same effort and innovation around GHG emissions will go into valuing natural capital and biodiversity in the coming years. Two areas will drive this: data collection and government policy.
Measuring biodiversity may be more complex than counting carbon emissions, but ‘big data’ makes it possible to assess multiple inputs. We expect risk disclosure frameworks similar to the Taskforce for Climate-related Financial Disclosure (TCFD) to emerge for natural capital. Fidelity recently published its own TCFD report and encourages investee companies to do so, as well as to disclose nature-based risks wherever possible. This has included working with confectionery companies on their use of palm oil grown in South East Asia and joining a coalition of financial institutions in Europe to call on investee companies to reduce deforestation that occurs along their supply chains.
Companies will find it increasingly difficult to avoid these kinds of obligations. Environmental policy is gathering pace, from the EU’s Green Deal to the US re-joining the Paris Agreement, and to China, Japan and South Korea announcing net zero targets. The latter developments highlight the growing role that Asia will play in setting the climate agenda as international ambitions mount ahead of a crucial UN climate change summit in late 2021.
2. Looking after employees, supply chains and communities
Employee welfare has taken on a new importance in the wake of the Covid-19 outbreak, with many companies seeking to protect their workers and preserve their businesses. Our November Analyst Survey reflected this trend, showing a big increase (compared with January 2020) in the number of analysts reporting that employee welfare was a high priority for companies.
In 2021, there will be more pressure on companies to take greater accountability not only for the welfare of their workforce, but for the community at large, and for the individuals in their (often) complex supply chains. This is driven in part by the severe effect that the pandemic has had on people’s livelihoods. Only a fifth of the global workforce of 3.3 billion has been unaffected by full or partial workplace closures as a result of Covid-19, according to the International Labour Organisation.
Some have been affected more than others. Women, for example, have lost more of their income than men. For every 100 men aged 25 to 34 living in extreme poverty in 2021, there will be 118 women, according to UN Women, and 121 women by 2030 if nothing is done. So we will be looking to companies to make genuine efforts to support their female workforce.
Workers in certain sectors have faced particular problems. In 2020, Fidelity raised awareness of 400,000 seafarers stuck at sea, unable to disembark at major ports after restrictions were imposed by national authorities in response to the pandemic. Fidelity wrote to over 30 companies in the shipping and charter sectors and has invited other investors to co-sign a letter to the UN calling for urgent action to address the situation.
Finally, supply chain management was a key theme in 2020, and in 2021 we plan further engagement on the auditing of suppliers for poor or criminal practices. In 2020, Fidelity became a founding member of Investors Against Slavery and Trafficking Asia-Pacific (IAST APAC), a newly-formed coalition that aims to prevent modern slavery and address human trafficking risks.
3. Redefining ethics for a digital world
Digital tools have become a lifeline for many during the pandemic, but they have also exacerbated economic inequality. Around half of the global population has no internet access, according to estimates from the International Telecommunications Union, with much lower levels typically in developing nations.
In rural and remote areas, an even greater proportion do not have broadband or a way to use online government services. This creates a divide between those that can access digital opportunities and those that can’t, even within individual countries. For example, 82 per cent of UK job vacancies advertised online require digital skills, according to the UK government. It is therefore incumbent upon policymakers, companies and investors to make digital accessibility a priority in 2021 and beyond.
Fidelity recently supported the launch of the World Benchmarking Alliance’s (WBA) inaugural Digital Inclusion Benchmark (DIB). The benchmark is the first of its kind to rank and score the 100 most influential global tech companies on their contribution to digital inclusion. Fidelity has committed to leading a collaborative engagement with investee companies alongside our WBA partners.
Other areas of digital ethics could affect the near-term valuations and long-term sustainability of technology companies. In 2021, we will monitor those we believe to be the most crucial: data privacy, misinformation, online fraud, online welfare and ethical AI design. Regulatory action so far has centred around the first three, but we believe welfare and design will become increasingly important.
The power of engagement
All of the themes above could be summed up as good corporate governance. As part of their broader governance responsibilities, companies will have to consider how best to recover from the effects of the pandemic in a sustainable way. Otherwise they may struggle to stay in business over the longer term. Companies with strong ESG characteristics outperformed in 2020 and should continue in future to attract more investor capital than those with lower ESG scores.
To improve the sustainability of investee companies, Fidelity will engage on our core themes for 2021 and those raised by our analysts. Much of the power of our engagement comes from our analysts and portfolio managers talking to companies on a regular basis about specific issues they need to address, rather than simply excluding them from portfolios. This is especially true in sectors and regions where environmental, social, governance and digital developments have been slower and asset managers have an even greater responsibility to push firms to act appropriately to create long-term value.
In this video, Hamish Douglass, the Chairman and CIO at Magellan, provides an update on recent performance, what the latest vaccine mutation could mean for markets, discusses Chinese stock Alibaba and outlines what he’s looking for in 2021. (Viewing time: 39 mins)
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