Emerging markets’ year to forget: why there is more to it than meets the eye

Emerging market stocks disappointed last year, but it’s worth looking under the bonnet of the headline market return to see the full picture, say the emerging markets specialists at Schroders.

Global equities enjoyed a third consecutive year of robust returns in 2021, in what some commentators dubbed ​ “the everything rally”. Everything except emerging market (and Japanese) equities, that is. With the MSCI World Index delivering a gain of almost 22% in US dollar terms, the MSCI Emerging Markets Index was down by over -2%.

But looking at these figures in isolation masks the reality of what happened across the 25 emerging markets in the MSCI Emerging Markets Index. From a country perspective, the returns dispersion was over 83%; from a gain of 55% in the Czech Republic to a -28% fall in Turkey. And of the 25 markets, 15 of them delivered positive returns. In fact, seven of these, which account for a combined 36% of the index, delivered gains in excess of 20% in dollar terms.

Emerging markets are a heterogenous group. It is nonetheless an important point, and understanding the different market dynamics is as relevant as ever. 

Regional performance

Of the three regions, emerging Asia and Latin America both recorded negative returns of around -5% and -8% respectively. In Latin America, only Mexico finished in positive territory.

By contrast, the more energy-heavy and cyclical emerging Europe posted an 18% return. Within the region, all markets except for Turkey advanced; a reversal from 2020 when every emerging European market was down.

Emerging Asia posted a negative calendar year return, following two years of gains.

Sector performance

Amid the strong recovery in global energy prices through 2021, it is perhaps not a surprise to see that energy was the best-performing sector, returning almost 22%. Utilities (13.2%) and IT (10.4%) also delivered double-digit gains in US dollar terms, with industrials (8.6%) and financials (8.6%) not far behind.

At the other end of the scale, consumer discretionary, real estate and healthcare all fell by -20% or more. Communication services was down -9%, followed by consumer staples at -5%.

Sector performance in 2021 also emphasises the outperformance of the value factor, which is reviewed below, with energy leading and financials and industrials also outperforming.

As with country performance, sector performance has also seen a reasonable dispersion in return by calendar year, as shown below. Of course, there have been sector categorisation and stock classification changes on various occasions over the past 20 years, but the point is still valid.

Size

While large capitalisation emerging market stocks had a challenging year in 2021, the outcome was very different for smaller emerging stocks.

The MSCI Emerging Market Large Cap Index was down -3.8%, with similar performance drivers to that of the main MSCI Emerging Markets Index.

By contrast, the MSCI Emerging Markets Small Cap Index registered a robust return of 19.3%. Why the stark difference? Small cap index performance was driven by the strong performance of India and Taiwan, which, along with South Korea, are the largest index countries. China finished in negative territory but it is a smaller share of the overall index and so was less of a drag.

Why does this matter?

It is important to emphasise that past performance is not a guide to future performance. And that is particularly important in emerging markets where the index has seen significant change, in terms of countries, sectors and stocks over the past 30 years.

This analysis is useful in highlighting the complexity of investing in emerging markets. Headline performance often hides what are a range of countries with economies at different stages of the economic cycle, with different economic structures, and different stock market compositions.

Over the last 20 years, the diversity within emerging markets has consistently led to high cross-sectional returns at both a country and stock level. This continues to be the case, and potentially creates opportunities to add value through country allocation and stock selection.

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