Over the years, the composition of EM has shifted towards domestic sectors like consumption, e-commerce, and financial services, and away from more global sectors like energy and materials, thus making EM less exposed to a global downturn than they were during both the Global Financial Crisis and the SARS outbreak. However, the crisis this time is more global and the economic hit is larger. Countering this is the unprecedented amount of fiscal and monetary policy support globally.

Source: UBS Asset Management, data as of 30 April 2020.

On the whole, EM company balance sheets have been improving since the Asian financial crisis in 1997/1998 and are more defensive, especially when compared to the US and Europe. That said, we may see a temporary increase in leverage in the coming months as EM companies work through the crisis period.

Source: Worldscope, Datastream, UBS IB, data as of 31 March 2020.

Governments across EM have stepped up with wide-ranging policy support.

On the monetary side, central banks in eleven EM countries cut rates in April (China, India, South Africa, Russia, Mexico, Poland, Turkey, Philippines, Peru, Colombia, and Pakistan). This has been possible because most countries in the EM space have maintained a prudent policy mix so far with respect to their real rates, and had room to cut rates.

On the fiscal front, governments are stepping up their efforts too. Russia for instance stated that the govern­ment plans to allocate ~3% of its GDP to fight the pandemic.

Even prior to COVID-19, the move to reduce global dependence on the China supply chain had started, driven by rising costs in China and rising automation reducing labor cost differentials, the trade conflict and tariffs, and a general desire to diversify China risk.

COVID-19 provides an additional impetus to diversify from the China supply chain.

Many companies are however looking at a ‘China plus one’ strategy, hence China will likely continue to be both an important production base and final market for companies. South-East Asia and India are potential beneficiaries of the ‘plus one’ strategy, and we’ll likely see more reshoring to North America, Korea or Japan.

COVID-19-induced changes in behavior have accelerated the shift from offline to online services, benefiting business segments like after-school tutoring, financial services, and healthcare diagnosis.

Companies are also stepping up investment in R&D and innovation, and there is growing demand for automated solutions. Additionally, the COVID-19 outbreak is spurring consolidation within many industries both in China and EM more widely.

At the time of writing, Chinese equities¹ have outperformed US² and European³ equity markets YTD. We see three reasons for this: firstly, China made a decisive, successful response in controlling the outbreak and this gave investors confidence; secondly, China moved quickly and showed strong capacity to stimulate and support the economy and, finally, US equities started the year being much more expensive than China.

For all the disruption to everyday life from COVID-19, we don’t see a meaningful impact on the long-term drivers that underpin EM.

Demographic trends within EM aren’t going to change because of the pandemic; the population of working age people in EM is still expected to grow 0.81%, on average, per year between 2020 and 2050, while it will decline 0.3% per year in developed markets.

This demographic change is significant because it means that the world’s new working population and consumer bases will come from EM and support domestic demand growth. And as incomes rise in EM, consumers are shifting their wallet share towards discretionary consumption and better quality goods and services.

So while it is difficult to predict the possibility and shape of a second COVID-19 wave, we are focused on companies that can withstand at least 12 months of very difficult conditions in terms of balance sheet and cash flows.

In terms of changes to our portfolio, we have reduced our exposure to banks across a number of countries. We like this sector structurally, but banks in many countries face near-term headwinds as they bear the brunt of the economic slowdown.

We have added to our positions in the internet and e-commerce sectors, especially outside Asia. Consumer and IT remain our key exposures both on absolute terms as well as relative to the index. We tend to be fully invested but continue to look for opportunities to rotate into potential long-term winners at appropriate price points.