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Redwheel: A revival of the physical world: Next Generation of Emerging Markets looks like EM in 2002

June 12, 2024
For professional investors and advisers only

The manufacturing winners of the last 20 years such as China and Korea look set to be challenged by the next generation of emerging markets (NGEN). We believe that countries such as Vietnam, Indonesia and Romania are on track to contest the world’s production hubs over the next two decades, driven by powerful secular tailwinds.

NGEN look set to be on a well-trodden path to economic success

Successful economic development is a well-trodden path. Since the Industrial Revolution of the late 18th Century, many countries have achieved economic success driven by young, educated workforces which go on to attract investment into their burgeoning, manufacturing-led industries. The Far East’s economic miracle over the last 50 years is the world’s latest example of this powerful secular pathway.

Populations have tended to migrate away from agrarian employment to focus on factory and office work. As a result, urbanisation levels have increased dramatically with a positive impact on consumption. The most potent example of this has been the transformation of China since the 1980s from a relatively low-income country to the second largest economy in the world.

Since 2010, the world has generally reverted to an historically normalised, moderate growth environment with stable trade and investment penetration ratios. Even a ‘flat’ world in terms of overall trade and investment penetration still leaves ample room for new EM economies to jump on the bandwagon and rise through the ranks of the export value-added chain in our opinion.

We believe that the historically proven development path towards labour-intensive, manufacturing export-led growth will benefit economies such as Vietnam, Hungary and Mexico. They are poised to potentially benefit from the same economic tailwinds that Korea, Taiwan and China experienced over the last few decades.

A new economic cycle focused on tangible asset investment

The period since the Global Financial Crisis (GFC) saw greater investment in innovation and intangible assets than in previous business cycles, enabled by an environment of low input cost prices, low inflation and a low cost of capital.

Over recent years, we have held the view that the world has entered a new economic cycle characterised by increased tangible capex. Investor priorities appear to be shifting towards the physical world, driving increased spending in areas such as renewable energy and the relocation of global manufacturing.

In previous cycles, countries such as China, Korea and Taiwan were among the beneficiaries. This time around, thanks to the success of these countries in industries such as semiconductors and the internet, we believe that smaller emerging economies will be the key beneficiaries of increased tangible asset capex.

COVID-19 accelerated supply chain diversification away from China, and the Russian invasion of Ukraine highlighted just how fragile the world’s energy infrastructure had become. The world continues to need to restructure its supply chains to reduce over-reliance on China, which now accounts for 28% of world manufacturing activity.[1] We believe that this development will lead to a similar capex cycle to the one we saw in the early 2000s.

The significance of such a structural shift cannot be underestimated as both the current and the capital accounts of NGEN economies would likely benefit. This would in turn attract foreign direct investment (FDI) and portfolio investments comparable to Japan in the 1950s and 60s, and China in the 2000s. Given such structural tailwinds, we believe that the surpluses on NGEN external accounts would likely be sustained and would be supportive for their respective currencies and equity markets.

Looking at the chart below, we are already seeing NGEN stock markets benefit as global capex increases.

Source: RRR is an acronym for reserve requirement ratio.Source: Redwheel, CLSA, Factset, Datastream – Refinitiv as at 31 March 2024. The information shown above is for illustrative purposes. Past performance is not a guide to future results. EM refers to the MSCI Emerging Market Index, World refers to the MSCI World Index and NGEN refers to the Redwheel Next Generation Emerging Market Fund.

Industrial leadership changes over time. The first generation of successful new products often gives way to improved versions by different manufacturers. For example, popular mobile phone manufacturers at the beginning of the cellular telephony age ceded market share to producers of smartphones in the 2000s. Similarly, the automotive industry is undergoing change with the combustion engine being replaced by electric vehicles. The dominant producers of electric vehicles, at least in terms of volume, are likely to be Chinese. Electric vehicle (EV) producers in China are scaling up their manufacturing to cement market leadership globally in this new technology. Gaining scale allows costs to be reduced, vehicles to be produced more cheaply and accelerates dominance of the mass market.

The NGEN Opportunity

Despite the attractive returns delivered to date, we believe that the valuations in NGEN markets remain attractive, trading at significant discounts to the majority of their larger emerging market counterparts.

Current volatility in global stock markets, driven by concerns over Federal Reserve policy normalisation or global geopolitical uncertainty, present a timely opportunity to invest in select NGEN economies as they progress along their long-term structural growth trajectories. We believe that the correlation of these markets with broader global indices is low as their fortunes are largely tied to their own economic fundamentals.

With several decades of investment experience in EM behind them, the team has identified three key structural drivers of growth: New Factories of the World, Travel and Tourism and Commodities. We anticipate that these themes will be the growth drivers for NGEN economies going forward. History rhymes if it does not always repeat.

Source: Redwheel, as at 30 April 2024. The information shown above is for illustrative purposes.

‘Travel and Tourism’ account for roughly 12% of world GDP and 1 out of 10 jobs globally are linked to travel.[2] As disposable incomes have risen over the last few decades, tourism levels have increased dramatically worldwide and we expect this structural trend to continue. The Covid-19 pandemic interrupted this trend but as the world has re-opened its borders, travel and tourism continue to recover. Emerging and frontier economies tend to benefit considerably as tourist arrivals increase in countries such as Turkey, Thailand, UAE and Greece.

The ‘New Factories of the World’ theme includes countries with low-cost labour and cheap manufacturing capacity that attract capital in search of higher returns. The world is now diversifying away from its manufacturing reliance on China for political and strategic reasons. Companies are looking to new economies in which to expand their production centres for the next two decades. Chinese firms themselves are often at the forefront of FDI into these new manufacturing locations as they also need to remain cost-competitive on the international stage.

One example of this transition is the Korean electronics giant Samsung which moved a large portion of its electronics manufacturing to Vietnam over the last decade from both Korea and China. In Hungary, we have recently seen the largest Chinese EV manufacturer, BYD announce plans to build a new manufacturing plant, making it the first Chinese car maker to build a passenger car plant in the EU.[3] Another example is Tesla’s announcement to build their new factory in Nuevo León in the north of Mexico. The US $5 billion investment will create 6,000 jobs and is the largest single investment in Mexico.[4]

And lastly, ‘Commodities’ look attractive in our view. Investing to achieve net zero emission targets, relocation of manufacturing capacity, increasing defence spending or building data centres for generative AI applications are all activities consuming significant amounts of materials and energy.

The supply of materials such as copper, uranium and aluminium that are crucial in these sectors remains constrained after a decade of under-investment. New mines and resources are predominantly being discovered across Africa and South America but costs of production have increased dramatically alongside greater ESG requirements for cleaner extractive methods.

The Russian invasion of Ukraine served to highlight the fragility of the world’s supply of energy, food and minerals. With limited spending into exploration and production, this fragile supply picture is likely to persist for many years.

The key potential beneficiaries of this are those NGEN economies that are net exporters of hard and soft commodities: Peru and Chile for copper and other base metals, Indonesia and Thailand for metals and soft commodities in addition to Colombia and the Gulf States for oil and gas.

We continue to look for opportunities within emerging market economies that are taking significant strides towards achieving their economic potential and stand to benefit from multiple secular tailwinds.


[1] Safeguard Global, as at September 2023

[2] WorldBank, as at 30th April 2024

[3] Financial Times, as at December 2023

[4] Reuters, as at March 2023

Important Information

Unless otherwise stated, all opinions in this article are those of the Redwheel Global Emerging and Frontier Markets team as at February 2024.  This article does not constitute investment advice and the information shown is for illustrative purposes only.

The Responsible Entity and issuer of units in CC Redwheel Global Emerging Markets Fund ARSN 630 341 249 and CC Redwheel China Equity Fund ARSN 656 117 421 (the Funds) is Channel Investment Management Limited ACN 163 234 240 AFSL 439007 (CIML). The CC Redwheel Global Emerging Markets Fund invests into Class F Shares in the Redwheel Global Emerging Markets Fund (Underlying Fund) which is a sub-fund of the Redwheel Funds, an open-ended collective investment company domiciled in Luxembourg. The Investment Manager of the Underlying Fund is RWC Asset Advisors (US) LLC (Redwheel). This email (including attachments) is subject to copyright, is only intended for the addressee/s, and may contain confidential information. Unauthorised use, copying, or distribution of any part of this email is prohibited. Any use by unintended recipients is expressly prohibited. To the extent permitted, all liability is disclaimed for any loss or damage incurred by any person relying on the information in this email. While every effort has been made to verify the data in the attached report, neither CIML nor Redwheel warrant the accuracy, reliability or completeness of the information nor do they guarantee the repayment of capital, the performance of the Funds or any particular rate of return. Past performance is not an indicator of future performance. The prices of investments and income from them may fall as well as rise and an investor’s investment is subject to potential loss, in whole or in part. This communication has been prepared for the purposes of providing general information, without taking into account any particular investment objectives, financial situation or needs. The Responsible Entity has issued offer documents for the Funds which contain important information and are available here. An investor should, before making any decision to acquire, or continue to hold an investment in the Funds, read and consider the PDS and any updated information and seek professional advice, having regard to the investor’s objectives, financial situation and needs. A Target Market Determination for the Funds is available here.

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