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Price Perspective - In Depth

Asset Allocation:

The Changing Face of Emerging Markets

Timothy C. Murray, Capital Markets Analyst

Executive Summary

  • Emerging markets have evolved, and investors now need to look at them through a different lens.
  • Infrastructure-driven sectors, such as energy, materials, and industrials, have become much less important drivers of performance, while consumer-oriented sectors, most notably information technology, have dramatically increased in importance. This evolution appears likely to continue, as many countries, led by China, transition toward more consumer-driven economies.
  • For tactical asset allocation purposes, the outlook for commodity prices is still quite important to the relative performance of emerging markets equities, but it is now part of a much broader mosaic of factors.
  • Partially due to the ongoing trend toward more domestically driven economies, emerging market fundamentals are becoming more impacted by country-specific factors, making broad generalizations about the asset class more and more difficult. This makes evaluation more complex for tactical asset allocation purposes, but it also means that the alpha potential for active management is higher.

Emerging markets (EMs) are a different animal to what they were 10 years, or even five years ago. The term "emerging markets” is now more a matter of benchmark classification as opposed to some common fundamental factor. While perhaps sounding like a subtle distinction, the importance is both high and far-reaching for investors, from both a bottom-up stock-picking perspective, as well as from a tactical asset allocation perspective.


Emerging economies, led by China, are the most important engine of incremental global economic growth. The dynamics of their economies, their growing share of world trade, and their increasing importance in global equity markets are trends of fundamental and long-term significance. According to projections by the International Monetary Fund (IMF) released in October 2017, emerging and developing economies will be responsible for 58% of all GDP growth over the next five years, with China alone responsible for 27%. By comparison, the United States is expected to be responsible for 17%.

Add to that the longer-term social aspects like urbanization and dramatically more attractive demographics than developed markets and it is easy to see why, conceptually, emerging markets equities seem as attractive an asset class as ever. Unfortunately, this attractive growth profile has not always translated into superior performance results—and in recent years, we have seen some important shifts in the dynamics of when and why emerging markets have outperformed (and underperformed) other regions.

Opening Quote In recent years, we have seen some important shifts in the dynamics of when and why emerging markets have outperformed (and underperformed) other regions. Closing Quote

In the late 1990s and early 2000s, EM equities delivered outsized returns relative to developed markets (Figure 1). During this period, many EM economies were boosted by China’s double-digit growth pace and massive investment in resources, leading to what was termed a “commodity supercycle.” This resulted in a virtuous cycle that benefited EM countries broadly—and several large countries in particular, such as Brazil, South Africa, and Russia, where natural resources are plentiful. It also meant that performance was heavily influenced by the direction of commodity prices.

However, as China began its transition to a more consumer-led economy, that powerful tailwind of rising commodity prices dissipated, and with it came a period of underperformance by EM equities (Figure 1). This caused much angst among investors as they tried to assimilate what had happened to the EM thesis. Were the unique qualities of emerging markets (i.e., superior economic growth and demographic advantages) enough to outweigh the cyclical exposure these markets held? Or had the experience of the 2000s proven they were simply an alternative way to increase exposure to commodity prices and other cyclically driven elements of the global economy? Recent evidence points to the former rather than the latter.  

FIGURE 1: EM Equity Performance Impacted by Shifting Dynamics 

Annualized Total Return in USD

Dec. 31, 2000–

Dec. 31, 2010

Dec. 31, 2010–

Dec. 31, 2017

MSCI Emerging Markets 16.21% -1.47%
MSCI World 2.81 5.20

Past performance cannot guarantee future results.
Sources: MSCI and FactSet. 


A look back over the last three years reveals that the relationship between commodity prices and EM equities has weakened significantly. EM equities had moved almost in lock step with energy prices from 2005 to mid-2014, but from 2014, they have moved much more independently (Figure 2A). This raises two questions: (1) Why did this relationship weaken and (2) Should we expect this to continue? 

FIGURE 2A: EM Equity Performance No Longer Riding Alongside the Commodity Cycle
EM Equities vs. Energy Prices, Cumulative Performance to December 2017

Past performance cannot guarantee future results.
Sources: MSCI and FactSet. 

FIGURE 2B: MSCI EM Correlation to CRB Spot Commodity Price Index
Five-Year Rolling, in USD, as of September 30, 2017 

Sources: MSCI and Credit Suisse research. 

A key factor in the change has been the sector composition of the MSCI Emerging Markets Index, where there has been a marked shift away from commodity and manufacturing areas into consumer-driven ones. Most notable is the growth of the information technology sector, while energy and materials sector weights have fallen dramatically.

Since 2012, the IT sector’s size withinthe MSCI Emerging Markets Indexhas doubled to almost 28% of theindex (Figure 3). That’s bigger than thetechnology weighting in the S&P 500 index at around 24%.1 Importantly, much of the change has been drivenby digital companies (i.e., “new tech”).

At the same time, the constituent weighting of the energy sector has almost halved, while the materials weighting has fallen to single-digit levels within theindex. Elsewhere, index sector weights have evolved less dramatically, but in a similarly thematic fashion. Those sectors in infrastructure-driven areas of the economy—industrials, utilities, and telecommunications—have trendedlower. Meanwhile, the sectors drivenby domestic consumption—consumer discretionary, health care, and financials—have trended higher.

FIGURE 3: Technology—The New Driving Force Within Emerging Markets
MSCI Emerging Markets Index—Sector Composition, as of December 31, 2012, and December 31, 2017 

Sources: MSCI and FactSet. 


In addition to falling representation within the index, the performance of commodity areas has also been poor during the current cycle (Figure 4). As we have witnessed the slowdown in the demand for resources, we have seen sectors exposed to this trend underperform the wider market. Meanwhile, consumption areas have provided relatively strong performance, led by the technology sector. This dynamic has exacerbated the ongoing decrease in correlation between commodity prices and EM equities, as not only have energy and materials become smaller constituents, but returns for the sectors have been negative, while the majority of the benchmark has performed positively, particularly the technology sector.

FIGURE 4: Change of Fortunes as the Commodity Supercycle Fades 

Past performance cannot guarantee future results.
Sources: FactSet, MSCI, and data analysis by T. Rowe Price. 


These trends in benchmark composition are unlikely to reverse anytime soon given the ongoing wealth creation and the organic rise in demand within local economies over time. Economists have long predicted that rising emerging markets incomes would propel a shift from export-led to consumption-led growth, and this shift is well underway across most areas of the advancing world. The rising middle class consumption story (Figure 5) shows few signs of stalling, with China alone having lifted more than 600 million people out of poverty over the past three decades.

China’s industrialization phase is clearly and intentionally fading, and as the economy has shifted away from an infrastructure and fixed asset investment led growth model, the consumption and the services sectors have generally picked up the slack. When looking at the data, we see clear evidence of this change, with services as a percentage of GDP growing (Figure 6).

FIGURE 5: Wealth Creation and Urbanization a Powerful Tool
Superior growth in middle class households 2015–2020 estimate. As of March 2016 

Sources: Euromonitor International and CLSA. 

FIGURE 6: China: An Evolving Story
China: Services Share of the Economy, 1992 to 3Q 2016 

Sources: Haver Analytics, IMF, and data analysis by T. Rowe Price. 

At the same time, more subdued economic growth in the developed world continues to erode the secular export theme within the whole of the emerging world. This leads us to suspect that EM fundamentals have evolved, and will continue to evolve, in a more self-reliant direction over time. China’s economy will not be the only one migrating toward a more consumption-oriented model.

An examination of the trade balance data shows that, indeed, many EM countries are seeing their trade balances narrow. Of the 10 largest emerging economies (based on GDP), the balance of trade for goods has narrowed over the last decade (Figure 7), except for Mexico. Net importers are generally importing less, while net exporters are also generally exporting less. 

FIGURE 7: Trade Balances Narrowing
As of December 31, 2016 

Source: FactSet.
*Data for India are unavailable prior to 2012, so 2012 number is shown. 


Partially due to this ongoing trend toward more domestically driven economies, emerging markets fundamentals are becoming more dispersed, making broad generalizations about the asset class more and more tenuous. You only need to look at performance on a country-by country basis to see that they cannot be viewed under one singular homogenous banner any more (Figure 8).

This is not a surprise to us given the ongoing economic and financial maturation within these countries. Few investors would group Japan, the UK, France, the U.S., and Australia together under a single banner, but since the emergence of emerging markets as an asset class 20 years ago, the fundamentals of India and Brazil have nonetheless been commonly associated with the fundamentals of the Philippines or Turkey, for example. However, the point of maximum fundamental correlation (remember the days of the BRICs ascending as one) was reached some time ago and has likely passed, leaving a more complex, and often confusing, situation in its wake.

A current view of sector weights further reveals the broad dichotomy of exposures by both country and region. Among the 10 largest countries by weight in the MSCI EM benchmark, information technology exposure ranges from over 60% (Taiwan) to 0%(South Africa, Russia, Mexico, Malaysia, and Indonesia). Meanwhile, energy weights range from 48% (Russia) to 0% (Mexico)(Figure 9). This dichotomy is also present on a regional basis, with information technology being the largest weight in Asia but barely represented in EMEA and Latin America (Figure 9). 

FIGURE 8: Emerging Markets Return Dispersion
March 2009 to December 2017 

Past performance cannot guarantee future results.
Sources: MSCI and FactSet. 

FIGURE 9: Sectors by Country and Region
Sector Weights by MSCI Country, as of December 31, 2017 

Sources: MSCI and FactSet. 

Price Perspective

Asset Allocation: The Changing Face of Emerging Markets

Asset Allocation: The Changing Face of Emerging Markets


1 Information technology weighting in the S&P 500 Index was 23.8% as of December 31, 2017.


Important Information
This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

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