Emerging Markets: investor letter Q4 2024

Your capital is at risk. 

President Xi “respects me and he knows I’m [expletive] crazy.” - Donald Trump

It is the time of year when nearly every firm in the financial industry is writing 2025 outlook pieces for its clients. Whatever your politics, both friend and foe can agree on one thing about Donald Trump – he is unpredictable. The soon to be 47th President of the United States, still the most powerful office on earth, will be held from January this year by a man who by his own admission is somewhat unpredictable. In these circumstances, it is probably best that any opinions expressed on what 2025 might look like should be held pretty lightly.

At Baillie Gifford we have long acknowledged the difficulties of accurate short-term forecasting. For us it seems that anticipating inflection points and waiting patiently for them is much easier than attempting to precisely pick entry points. It also means that for us, recognising and investing in long term secular trends is much more productive use of our time and our clients’ money than attempting to accurately forecast a company’s earnings for the next quarter or the next year. The result of this is that we are unashamedly long-term investors who try to appraise (not always successfully!) what a company will look like in five or ten years’ time. This means that we will probably looking to harvest the most successful investments we have made on our clients’ behalf when the 48th and 49th US Presidents will be in office. Our focus remains on finding great companies that will adapt, whatever the political and geopolitical weather.

Given an uncertain short-term future, it is probably worth looking at what has happened in the largest Emerging Markets over the last year and whether this has changed our view from either a top down or a bottom-up perspective. After three years of decline, the Chinese market delivered a positive return in 2024. While a part of this may have been driven by speculation on the ultimate size of Beijing’s stimulus package, we believe the coordinated announcements since September marked a significant policy pivot from the top, which should support growth and sentiment relative to a low baseline. China still trades at a significant discount compared to other emerging markets (and roughly 50 per cent compared to US) on a price-to-earnings basis.

We have consciously pursued a neutral position in China through 2024. While low valuations and wretched sentiment might have encouraged us to be overweight, the risk of geopolitical escalation has stayed our hands. However, where there have been complete sales or reductions in the Chinese holdings in the portfolio, these have typically been recycled into new holdings in China or additions to the remaining holdings. Given still attractive valuations and a Chinese government that appears to be to have re-prioritised growth, the sharp rally in September amply demonstrated the risks of being too underweight. In summary our view in China remains unchanged; in the shorter term we are optimistic; in the medium term we believe there are still selectively great bottom-up investment opportunities; in the longer-term Washington and Beijing want different things.

India has outperformed for four consecutive years. There is plenty of optimism surrounding India: a structural property boom, an increasingly affluent middle class, and strong diplomatic leverage on both sides of the geopolitical divide. However, high valuations have deterred us from closing the underweight position in India and we take comfort from the fact that higher growth potential is on offer at more attractive valuations elsewhere in Emerging Markets. We continued to take profits from some of our cyclical exposures in India, hold a modest underweight in the country, and remain selective. India boasted the largest number of IPOs globally in 2024 (327) and we recently participated in one of these – Hyundai Motor India.

AI has obviously been a big driver of stock returns, no more so than in Taiwan, which has hit all-time highs and is the home of TSMC. TSMC recently reported very strong 3Q24 results, with notably strong margins. TSMC is now working with almost all the AI innovators which gives it unparalleled insight into the type and quantum of demand coming down its pipeline. Foreign investors have had concerns over TSMC’s Taiwan base given geopolitical and resource (electricity, water) issues. TSMC’s foundry in Kumamoto, Japan began operations this year, with a second now planned to commence in 2027. In Phoenix, Arizona, TSMC has two facilities due to commence production in 2025 and 2028 with a third leading edge facility expected to be in operation by the end of the decade. Finally, TSMC also announced a new facility in Dresden, Germany with production to commence in 2027. While Hsinchu, Taiwan will remain at its core, geographical diversification is reducing the risks.

South Korea, by contrast has been less positive. Most recently the news has been focussed on President Yoon’s attempt to impose martial law on the country. That this was summarily blocked within hours by the National Assembly speaks volumes to the degree that democracy is now firmly embedded in the southern part of the Korean peninsula. Otherwise, 2024 has been more challenging from a corporate perspective. Battery maker Samsung SDI has seen weaker demand from EVs and increased Chinese competition. Nevertheless, it is a beneficiary of Northvolt’s difficulties and in the longer term appears to be making real progress in solid state batteries. Likewise, Samsung Electronics has also struggled over the year. It has lagged its competitor SK Hynix in qualifying with NVIDIA with its leading HBM chips at a time when the gap between its foundry business and TSMC has widened. In addition, its ubiquitous smartphone business is seeing greater competition from Chinese brands, particularly in the foldable screen segment. Samsung Electronics is currently being reviewed by the investment team, but a short note can be found here.

The Brazilian market has pretty much round-tripped this year. GDP growth accelerated during the year, posting 4.0 per cent YoY growth in 3Q24. At the same time the Brazilian Central Bank was cutting interest rates as inflation fell. The potent positive combination was broken once it became clear that the government was reluctant to make the fiscal cuts necessary to reduce the deficit and to stop the upward march of public debt. Subsequently, the Central Bank has reinforced its independence credentials by responding to loose fiscal policy on the part of the government by raising interest rates again to tighten monetary policy. While this stand-off has been unhelpful to stock market performance in general, the two largest Brazilian holdings have been largely unaffected; Petrobras’ share price is typically driven by the oil price, while Mercadolibre is more exposed to the structural growth in ecommerce across Latin America.

In Mexico, the market sold off following the election of President Scheinbaum, protégé of outgoing President Andres Manuel Lopez Obrador. Such was the scale of her success and the Morena party, the market began to be concerned about constitutional changes for which she could command the necessary majority. President-elect Trump’s pronouncements of tariffs, immigration and phenol have only deepened market gloom. Despite this gloom, the Mexican stocks in the portfolio have continued to perform decently in operational (if not in share price terms). FEMSA continues to expand its chain of Oxxo convenience stores at a prodigious rate, while Banco Banorte has continued to see the benefits of global companies ‘near-shoring’ to the US in Mexico.

What will happen in 2025 is impossible to foretell, what the world will look like in 2030 or 2035 is somewhat easier. The scope and scale of AI is likely to grow and with it demand for the ‘picks and shovels’ that are largely manufactured in Emerging Market countries. The energy transition will continue unevenly, perhaps driven by national security as well as environmental concerns. This will require significantly more raw materials, such as copper, which are mostly found in Emerging Market countries. Large swathes of the world remain unconnected, unbanked and underserved. The scope for local champions to fill these needs present huge opportunities for local entrepreneurs and businesses. We cannot know for sure when these powerful trends translate into stock market performance, but we can certainly anticipate it.

Performance

2024 has been marked by the same companies often yo-yoing from the top contributors to the top detractors (and vice versa) on a quarterly basis. Given that little has usually changed in terms of the long-term prospects for these companies, it highlights once again the vagaries of paying too much attention to short term share price performance.

A notable recent example is Latin American platform, Mercadolibre. As a starting point ecommerce penetration in Latin America is about 12-13 per cent of retail sales. This compares to over 25 per cent in the US, over 30 per cent in the UK and over 40 per cent in China. While it will take time for Latin America to approach these levels, clearly there is scope for growth. In addition to its ecommerce business, Mercadolibre has a sizeable fintech business offering payments and credit services. Consider Mercadolibre’s major markets; in Brazil ~16 per cent of the population do not have a bank account; this rises to ~28 per cent in Argentina and ~50 per cent in Mexico. Again, plenty of scope for growth. Mercadolibre was weaker this quarter because its 3Q24 results disappointed on margins. These were compressed because the company decided to invest more in these businesses. Given the scale of the long-term opportunities outlined above, this seems a sensible use of shorter-term profits.

Bank Rakyat in Indonesia has also been a bit of a yo-yo through the year. Indonesia has a population of ~276 million spread over ~18,000 islands and perhaps unsurprisingly ~48 per cent of the adult population do not have a bank account. Bank Rakyat has a clear mandate to increase financial inclusion to the extent that over 80 per cent of its loan and financing book is lent to micro, small and medium sized businesses. To service its customers Bank Rakyat has invested in its own satellite and a series of ‘floating’ branches to service remote locations. Currently, Indonesian interest rates remain high but with a large proportion of fixed rate loans, Bank Rakyat will be a beneficiary once the cutting cycle begins in earnest.

Indian conglomerate Reliance Industries has also been amongst the top contributors and the top detractors depending on the quarter. However, it is fair to say that the short-term outlook for the company has deteriorated of late. Its refining and petrochemicals business has been hurt by Chinese exports though there has recently been a cut in the VAT rebate for fuel oil exports by the Chinese authorities, which will help at the margin. Longer term the outlook looks brighter with the scheduled closure of capacity in the US and Europe. For example, Grangemouth - Scotland’s only and oldest refinery – is sadly scheduled to close in 2025 as it increasingly struggles to compete with bigger, more modern facilities in the Middle East, Asia, and Africa. Reliance’s retail business is currently in consolidation mode following rapid expansion, while JIO, its telecoms business only recently applied a tariff hike. Growth in the coming years is likely to be driven by the nascent New Energy business, where visible progress would reignite Reliance’s growth outlook.

In contrast to the above, SEA Ltd has been one of the most consistent contributors through the year. In the last couple of years, the company has been through a tough period while its gaming blockbuster ‘FreeFire’ stalled, TikTok providing a serious challenge in ecommerce and higher interest rates impacted SeaMoney. Now SEA is showing impressive momentum across its three businesses. FreeFire has rejuvenated itself by becoming more streamlined and focused on localised content; Shopee, its ecommerce business is progressing smoothly in profitability, SeaMoney now has ~12 million people using its financial products. This is a stock where patience has been rewarded as the company navigated and adapted through a number of challenges but now appears to be powering ahead.

We remain enthusiastic about the spread and composition of the EM portfolios. Obviously, there will be short term fluctuations in performance which, in all honesty, we have little control. However, in the long-term share prices ultimately follow earnings growth (in hard currency terms) and we continue to be excited about the prospects of the companies in the portfolio.

This is an Emerging Markets commentary based on Emerging Markets All Cap and Emerging Markets Leading Companies. Not all stocks may be held, but themes of this commentary are representative of these investment strategies

Source: Revolution, MSCI. US dollar. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite. 1 year figures are not annualised.

Past performance is not a guide to future returns.

Legal notice: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

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