The emerging market consumer – how should you play that investment theme?

1st March 2013

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With most emerging market experts highlighting the region’s shift from export-oriented to domestically driven, rising consumerism is a massive investment theme writes journalist James Smith.

Many fund managers – whatever their region of choice – see growth in Eastern consumerism, particularly China, as the dominant market driver of the coming decade, as commodity demand dominated much of the 2000s.

To run through the fundamentals for its growth, many emerging countries are urbanising and seeing associated rises in in income levels, with penetration rates low across most consumer goods. Global consumption is worth a total of $32 trillion – more than 50% of world GDP – and patterns within this are changing as current generations spend much more than their parents on healthcare for example.

Despite a wobble for China last year, the country now seems back on solid ground and few commentators would dispute the current dominance of emerging over developed, at least in the macro sense.

The concern with any consensus view however is how quickly trends come to be seen as one-way bets. To use the most extreme example, technology was a massively pervasive investment story in the late 1990s but clearly failed to translate into meaningful returns for all but the lucky few that got out at the right time.

While the general consumer trend is clear, a further iteration is in the rapidly developing luxury goods market, with the lion’s share of demand again coming from the increasingly wealthy east. Putting some figures on this, Julius Baer – among several groups running Luxury Brand portfolios – predicts another solid year for this sector, with growth of six to eight per cent. Manager Scilla Huang Sun says emerging markets already account for half of luxury sales and this number is expected to grow further. “Worldwide wealth is predicted to rise by almost 50 per cent by 2017 and there are now more millionaires in Asia than in Europe,” she says. “Wealth creation in emerging countries is driving the growth of luxury, with China likely to surpass Japan as the second wealthiest country in the world in the next five years. Its luxury consumption, already 30 per cent of the market, is expected to grow at double-digit pace in the coming years.”

A key factor in the luxury goods story – in contrast to the broader consumer theme – is that the vast majority of companies are Western.
Chinese people often purchase luxury goods on trips to Europe or Hong Kong for example and in 2012, the number travelling outside China increased by 25 per cent.

Apart from China, rising disposable incomes and desire to ape the luxury brands of the West across Brazil, Russia and the Middle East also continue to drive the sector.
Sun adds: “Investing in luxury goods offers exposure to the rapid growth of consumption in emerging markets via well managed western companies with strong balance sheets and financials. One third of the companies we invest in have a net cash position and the average operating margin is 18 per cent.”

Like the people who tend to buy their wares, most luxury goods businesses have proved fairly immune to the credit crunch and more recent eurozone crisis, with brands including Prada, Ferragamo, Michael Kors and Brunello Cucinelli coming to market with IPOs in recent years. Given this backdrop then, is emerging market consumerism a one-way – albeit somewhat volatile – bet and are luxury goods funds the next big thing for UK investors?

With some much bullishness on emerging markets around, it is refreshing to hear a counter argument, largely focusing on the region’s universally lauded young age profile (seen as a key prop for rising consumerism).
In a note to clients earlier this year, UBS head of emerging market fixed income and currency strategy Bhanu Baweja notes the lazy optimism of every EM obtaining what he calls a ‘demographic dividend’.
“As global imbalances are slowly being resolved, emerging markets growth seems to have lost the oomph of 2002-07,” he says.
“Then, EM supplied the real and financial goodies for an over-consuming, over-constructing and over-levered developed world.

Trend growth, investment and savings rates in EM rose, credit ratings almost uniformly pushed north. Now, a clanking noise of cleaning up has replaced the music and, sure enough, EM’s growth premium over the developed world is falling.”

According to Baweja, no nation would want to miss out on the demographic dividend – strong per capita income growth, sustained higher savings, better external imbalances, improvements in standards of living. “But what does it take to harness it?” he asks. “What is required is an appropriately skilled labour force, in numbers well in excess of dependents (those in age groups 0-14 and above 65), and with gainful jobs. Youth bulges have led to strong economic gains in many societies but there are also plentiful examples of them having led to armed conflict.

“The French revolution, the Russian revolution, and more recently, the Arab Spring were all driven by a combination of rising proportion of youth in the population and stagnating real incomes. Whether a nation harnesses its demographic dividend depends on whether policy will encourage or crowd out growth. The evidence today in tomorrow’s demographic stars is less than encouraging.”
Whatever your view on this, most predictions suggest a bright future for companies linked to growing consumerism. But underlying macro trends are not enough to guarantee returns and investors should do their due diligence as they would on companies not so blessed by demographics.

A further concern about this opportunity is price. Going back to the technology example, the fundamental story behind the sector remains intact but the problem came when businesses with no track record were bid up to unsustainable multiples.
No one is suggesting valuations among consumer stocks – even in the luxury goods space – are anywhere near that stretched but they are expensive and paying over the odds for anything is the quickest way to lose money.

Ever since the tech crash, UK investors remain wary of sector funds and there are valid arguments for not betting everything on one area and playing themes through broader mandates.
In any case, given how much many expect emerging market consumerism to drive global GDP in coming years, you would hard pressed to find a fund not benefitting from the theme in some way.

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