On this episode of The Long View, Sudarshan Murthy, co-portfolio manager on all GQG investment strategies, discusses the historical performance of emerging markets, how current US policy could affect their future, and opportunities for investors internationally.
Here are a few highlights from Murthy’s conversation with Morningstar’s Dan Lefkovitz.
How Emerging Markets’ Current Underperformance Reflects the Danger of US Exceptionalism
Dan Lefkovitz: So I wanted to turn to emerging-markets equities, although maybe later in the conversation we can talk about the US and other markets. But GQG just published a really interesting paper called “Turning Tides in Emerging Markets,” and there’s some great historical perspective. You look at various cycles of emerging-markets performance. But you also note that we’ve been in a prolonged period of underperformance for emerging-markets equities. 2024 was another down year for emerging markets relative to the US. How do you explain the disappointing returns for emerging markets extending back so long, decade-plus now?
Sudarshan Murthy: Yeah, but these things, they go in cycles, as you pointed out. If one takes a really long-term view, let’s say since the late ‘80s, you can actually break it down. To phases when emerging markets like a bull market did well and those are then followed with a bear market. We often joke that good times lead to bad behavior and that produces bad outcomes. And tough times create good behavior that leads to good outcomes. Does that explain it, but look, if you look at it, late ‘80s, early ‘90s bull market in EM, what triggered it? One of the reasons is that both India and China realized that they had to liberalize. China probably did more than India and that benefited them over the next 30-plus years. India went in for a partial liberalization, which had its ups and downs at the time.
But then if you look at the late ‘90s, there were some excesses in EM and that led to challenges. But then that also set the ground for a better regulatory framework in EM. I do feel that the Asian financial crisis was a wake-up call to many of the regulators—be it the banking regulator in Thailand or Indonesia and across various countries—and that did tighten norms and make it more conservative. And you can see that in the long term, right? Indonesian NPL numbers was around the 30% during the Asian financial crisis, if not higher, and that over time has continued to come down. Pre-covid, it was about midsingle digits. And those kind of improvements happened because the regulators are being very proactive on taking steps.
The bear market of the late ‘90s did set the groundwork for the bull market that happened, right? And at the same time, you had the dot-com crisis in the US. So, you got a situation where the US stock market was perceived as somewhat not that an great investment and EM did well. And in that particular phase, the 2001 to 2010 time frame, China was clearly the engine. It did a large part of the global improvements.
But your question was 2010 onwards. I think there are two aspects to it. One is US exceptionalism post-GFC has been held by low interest rates. And EM has had its challenges for the last 15 years. It goes back to what I was mentioning earlier: Good times produce bad decisions and then creates bad outcomes, and then tough situations create good behavior and sets up the stage for good outcomes.
At the same time, if you look at countries like India, Brazil—they have made some significant reforms that are going to help them for the long term. I’ll give the example of India before jumping to Brazil. India introduced the bankruptcy law and real estate reform, both in the 2016 time frame. Now, the bankruptcy law is actually a big deal. Because I remember I started my career as a lending officer in an Indian bank 25 years ago. And the joke at that time, which my bosses would tell me, is that when you’re lending to a business, the management comes in a shabby ambassador car, which is one of those old-fashioned cars that you would have at that time. But when they come to renegotiate the loan, they’re coming in a nice Mercedes car. So, but that was true. That kind of behavior, there’s an element of truth behind it. And the reason for that is banks did not have the power to enforce terms on management that was defaulting. They could go to court, but that would take years, if not decades.
The bankruptcy law kind of changes that. Now, banks know that they can take management to court. In a span of few months, they can take the assets away from the management, and that creates a virtuous cycle. It promotes good behavior on all the stakeholders. And you can see that over time, the banking sector in India is much better than what it was before. Now, you see a similar dynamic in Brazil, for example, the SOE reform law, introduced somewhere around 2016. That acts as a deterrent for executives in the SOEs. They realize that if they commit bad behavior, they can literally go to jail. And that’s a wonderful deterrent.
Can Emerging Markets Withstand Higher US Interest Rates?
Lefkovitz: I want to come back to both India and Brazil later, but I did want to ask you, you mentioned interest rates, US interest rates. And there used to be this perception that the performance of EM equities and debt were very closely tied to US interest rates. When US interest rates were cut, that was good for EM, and when they were tightened, that was bad. What’s your view on the relationship?
Murthy: Look, I think any company in emerging markets that has gone through cycles learns how to adapt to higher interest rates. And generally, these economies run at higher interest rates. So going from, let’s say, 8% to 12% is not as bad as when someone goes from a 1% to a 5%. The impact is a lot higher. And when we talk to management of companies in these countries, you realize that they had to be a lot more sophisticated in navigating this. So for example, what does that mean? The systems are built such that pricing decisions can be taken much faster … They’re able to manage changing prices at a faster rate. It’s stable stakes for them. The other part of your question is, in an increasingly deglobalized world in so many ways, countries that have a large domestic market can be attractive because they are somewhat insulated from everything else that happens. Those companies are somewhat insulated from what’s happening elsewhere.