Despite many near-term concerns for emerging markets arising since the U.S. election, there are reasons to be optimistic about their long-term prospects—in part due to consumers, who continue to offer structural growth opportunities.
A Structural Growth Potential
Emerging markets benefit from multiple drivers of consumption growth including, favorable demographics, urbanization (which should support greater growth than implied by demographics), and growing middle class. Indeed, household income distribution is shifting in emerging markets, with tens of millions of consumers moving into the middle class. As a result, emerging markets are forecast to be responsible for 61.2% of urban consumption growth from 2015 to 2030, according to McKinsey & Co.
With an average GDP per capita of about $7,000, emerging markets are in the “sweet spot” of discretionary spending. As illustrated below, when GDP per capita increases, spending accelerates and consumers broaden purchases to include more discretionary items. For example, the growth potential for healthcare and tourism accelerates when GDP per capita reaches the threshold of $10,000. Importantly, large emerging markets such as China, Indonesia, and India have significant way to move up the curve, providing strong growth potential for discretionary products and services going forward.
A Broadening Opportunity Set
So, where do we look for opportunities? In emerging markets, a wide range of companies—from toothpaste makers to ecommerce businesses—are all adapting to the evolving emerging consumer and are well placed to benefit for strong secular growth. Because of this, we believe it is important to look beyond the strict index definition of consumer sectors, i.e. consumer discretionary and consumer staples, to all industries that directly serve the emerging consumer, including healthcare, tourism, consumer finance, telecommunications and the key internet sector.
Including all these consumer-driven companies in our universe doubles our opportunity set compared to just focusing on traditional consumer sectors. While the consumer discretionary and staples sectors comprise just 19.4% of the MSCI Emerging Markets IMI, consumer-driven industries* comprise 39.5%.
It also provides higher quality and growth opportunity sets. While the traditional consumer sectors have materially higher return on equity (ROE) than the MSCI Emerging Markets IMI, the broader consumer-driven universe has an even more attractive ROE (five-year average): 16.50% for the index vs. 18.22% for traditional consumer sectors vs. 19.46% for broader consumer-driven companies. The results are similar when we look at the long term prospective earnings per share growth, which is 13.62% for the index vs. 15.44% for traditional consumer sectors vs. 16.25% for broader consumer-driven companies, as of November 2016.
Let’s discuss some specific consumer-driven sectors.
Beauty and Personal Care
One of the strongest growth trends in emerging markets is in beauty and personal care products. The amount spent per capita on these products in 2015 was $37 in China, $17 in Indonesia, and $9 in India… compared to $249 in the United States. But these least penetrated countries are also seeing the most dramatic growth in this sector, with India and Indonesia posting 12% and 14% growth p.a. respectively vs. 2% in the United States. Also the medical beauty market—for dermal fillers and Botox— has been growing rapidly in emerging markets. Particularly Korea and Brazil are among the largest and fastest growing markets for aesthetic treatments like Botox.
Another trend is education. In 2015, the United States spent $14,579 per student on primary education, and the more advanced emerging markets (particularly in Asia, where education is held in high esteem) were not far behind. The amount spent in South Korea was $11,180, for example, and in Taiwan $9,843, which is above the $9,000 spent in Japan. While China only spent $2,048, primary education spending has grown at a 16% compound annual growth rate (CAGR) over the past 15 years. More broadly, education spending growth in emerging markets has outpaced developed markets.
In Brazil, higher education is in great demand. Brazilian workers with higher education command a 160% premium over unskilled workers, the greatest premium of any large economy, almost two times that of the United States, according to OECD research.
Tourism is also driving growth in the emerging markets, and is an interesting consumer-driven theme. Chinese tourism spending has increased 13-fold in the past 10 years. Yet, only 9% of the population holds a passport. This relatively low penetration suggests that as the middle class increases and gains a taste for travel, tourism will continue to be a significant growth driver, creating investment opportunities throughout Asia, and impacting everything from Japanese duty-free operators to Korean cosmetics companies, as well as airport operators in Thailand and Australia.
Ecommerce and Internet
Also consumer-driven are ecommerce and Internet businesses. In China, ecommerce penetration is 17% of business-to-consumer retail sales, and we believe should increase at least one percentage point per year for the next three to five years. Meanwhile, Chinese Internet revenues grew from 131 billion renminbi in 2012 to 392 billion in 2015, and are expected to grow around 30% in each of the next two years, according to Bank of America Merrill Lynch Global Research. The country’s major online retailer has more than 420 million active buyers, 40% more than the comparable U.S. company.
But the Internet boom in emerging markets extends beyond e-commerce. China is the largest online gaming market worldwide, with 24.3% of market share in 2015 (vs. 24.0% for the United States), and it is growing at the fast rate in the world at 23% year over year in 2015, according to Morgan Stanley estimates.
Despite the noise from the U.S. election and potential implications for emerging markets, the case for strong consumption growth in emerging markets remains compelling. From basic consumer staples to sophisticated Internet-based business models, emerging market companies are offering an evolving mix of innovative consumer-driven products and services across industries. We see opportunity in these consumer-driven industries as they provide higher growth and returns in emerging markets.
*Consumer-driven industries include the following: consumer discretionary, consumer staples, consumer finance, life and health insurance, healthcare, airlines, airport services, communication equipment, internet software and services, home entertainment software, hotel and resort REITs, residential REITs, retail REITs, and telecommunications services.