Emerging market stocks navigate seesawing markets

Q3 2021 Putnam Emerging Markets Equity Fund Q&A

  • The number of startups is rising in several markets, including China and India.
  • Innovation, including fintech, is driving growth across emerging market companies and countries.
  • Despite some volatility over the last few months, our outlook remains bullish for emerging markets.

How was the investment environment for the third quarter?

Emerging market equities trended lower during the three-month period. Other key global equity-market indexes also seesawed during the quarter with some managing to hold on to gains, driven by widespread Covid-19 vaccinations, fiscal stimulus, and signs of economic recovery. The S&P 500 Index, a broad measure of U.S. stocks, rose 0.58%. But the MSCI World Index [ND], a broad measure of equity securities from developed countries, dropped 0.01% during the period.

Emerging markets began to face some challenges in the period. Market volatility was driven by the push and pull of a recovering global economy under pressure from various risks, including the spread of the Covid-19 Delta variant, the Federal Reserve's communications about tapering its bond-buying program, and China's real estate woes and regulatory crackdown on its internet behemoths. China, the world's second-largest economy, is a key investment and trading partner for emerging market countries.

For the third quarter, the Putnam Emerging Markets Equity Fund fell 8.50% compared with a decline of 8.09% for its benchmark, the MSCI Emerging Markets Index [ND]. Despite some volatility in the first half of the year, my outlook remains bullish for emerging markets.

Why should investors consider emerging market stocks?

Innovation is driving growth across emerging market countries. In our view, the developed world no longer holds a monopoly on invention. We are discovering companies that offer unique fundamental investment opportunities across the broad emerging market universe. These are the so-called unicorns — privately held startups valued at $1 billion or more.

Unicorns number about 600 globally, and about half are in the United States. China comes in second and India third in amounts of unicorns. South Korea, Brazil, and Indonesia are also among the top 10 countries for these unicorns. Clearly, emerging markets are home to some cutting-edge companies. We believe many of the leading companies of the next 20 years may originate in emerging markets. The dominance in three main areas — semiconductors, fintech, and electric vehicles (EVs) — is creating some exciting investment opportunities, in our view.

What is your near-term outlook for emerging markets?

Despite some volatility in the last few months, our outlook remains bullish for emerging markets. Investors should consider emerging markets for several reasons, including portfolio diversification and because businesses in these regions offer so many of the world's future growth opportunities. In July, the International Monetary Fund (IMF) forecast emerging market economies will expand 6.3% this year compared with 5.6% for advanced economies.

That said, this growth will be uneven across the developing world, and several countries are still struggling with Covid-19. Over 70% of the emerging market index — countries such as Korea, Taiwan, and China — have dealt with the pandemic more effectively than much of the developed world. Unfortunately, other countries, such as India and Brazil, continue to face major Covid-19 challenges. This, of course, is why we believe active portfolio management is key.

We are carefully monitoring the Covid-19 situation across all economies and its potential short- and long-term impact on businesses. Our strategy emphasizes bottom-up stock selection across geographies and sectors and focuses on high-quality companies with strong balance sheets. We tend to avoid countries, companies, and currencies that we believe are more vulnerable to external macroeconomic shocks. We believe this approach has helped us add value to the portfolio, especially in recent periods of increased market turbulence.