Global Perspectives: Charting The Trajectory Of Innovation In Emerging Markets

Janus Henderson

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By: Daniel J. Graña, CFA, Matthew Culley & Adam Hetts, CFA

In the latest episode of our Global Perspectives podcast series, Portfolio Managers Daniel Graña and Matthew Culley discuss the role of innovation as a key force driving growth in emerging markets (EM) over the next decade and explain how ESG investing in EM differs from developed markets.

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Key takeaways:

  • Innovation in emerging markets – and the asset class returns tied to that innovation – has lagged developed markets by about 10 years, but we believe we are reaching a point of equalization where novel solutions begin to benefit both emerging economies and their equities markets.
  • One of the key differences is the inclusionary nature of innovation in EM. By broadening the scope of who can participate in healthcare and the financial system, innovation unlocks business potential while driving positive health and economic benefits.
  • By solving for these inequalities, innovation addresses many of the “E” and “S” problems in emerging markets, making EM a strong candidate for ESG investing.


Adam Hetts: Welcome back to Global Perspectives, and today we’re talking through a much-needed update on emerging market equities. In the next 15 minutes or so, we’ll discuss the outlook on emerging markets in general, the role of innovation as a key force driving EM over the next decade, and what sustainable or ESG [environmental, social, and governance] investing means in emerging markets compared to developed markets. To help me with that, we’re joined by Daniel Graña and Matthew Culley, both Portfolio Managers on Janus Henderson’s Emerging Markets Equity team. So, Daniel, Matt – welcome to the show.

Daniel Graña: Thank you.

Matthew Culley: Yeah, I’m really excited to do this.

Hetts: So, Daniel, I’m going to start with the most loaded question, which is, your general outlook on emerging market equities. There are so many negative headlines to grapple with, but emerging markets are ultimately where the majority of global growth is happening. So what’s the balance here between optimism and pessimism in emerging markets?

Graña: For a sustainable rally, the market needs to find a new equilibrium. The market needs some clarity on the terminus of U.S. interest rates against the dollar. Maybe not necessarily getting to that terminus, but just being able to feel it, touch it. We need some clarity on the depth of the likely recession of the developed world, and we need some sense of what’s going to happen in China in terms of the policy pivot on property and COVID, for instance. So there are some legitimate questions. However, longer term, I would say there’s some considerations. The rise of geopolitical considerations and the rise of populace pressures in DM is, basically, they both have undermined the case for globalization, and when you want to export your way to economic prosperity like Korea and Taiwan have done, this business model is going to be harder for other countries, so active management is going to become even more important in choosing which countries will do well in this changed future, in this world of sort of fragmenting end markets, and which ones are not well positioned. But what I would like to say is, what really gets us excited about the future of EM equities is the rise of EM innovation, and this is the third pillar of growth.

Hetts: So another key trend that your team has talked about is the bipolar or the multipolar world that we’re entering into as far as globalization, or maybe the lack thereof, in the post-COVID trend. So from an emerging markets perspective, Daniel, what would you say are those investment implications of that bipolar or multipolar world?

Graña: It’s going to be harder and harder to bring intellectual property across the dividing line, whether it’s telecom infrastructure IP – intellectual property – from Huawei into the west, or semiconductor equipment from the west into China. Companies are increasingly going to have to choose which end market they will serve, reducing the end-market opportunity. And we will also see the rise of Chinese national champions, which are going to be supported by government policy aimed to push out displaced Western companies. Another sort of reality of this is that we’re going to see more supply chain diversification; that’s going to lead to flows, foreign direct investment flows, into places like Vietnam, Indonesia, India, Mexico, and others. So for example, today only 5% of Apple’s products are produced outside China, but that’s likely to jump up to 25% in the next few years. So one consequence of this diversification, though, I want to point out is, it is inflationary, because if the marginal investment dollar is no longer placed in the lowest-cost manufactured goods and services, but in the second-, third-, or fourth-best location, then that does have implications for the end consumer. So in short, the investment implications of a bipolar world means that a few EM countries will benefit from this nearshoring and friend-shoring. And secondly, some innovative Chinese companies will have the domestic Chinese market largely to themselves. So multinationals have to be careful in that world.

Hetts: So on the note of China, then, more broadly speaking even outside of just the bipolar, multipolar world, is how broadly are China’s economic drivers changing?

Graña: China’s secret recipe, or maybe not-so-secret recipe, is to become the global workshop, joining WTO, providing very attractive labor, great logistics, great infrastructure, to then become the global manufacturing workshop. Along with that, would drive urbanization and create this virtuous cycle of being able to export your way to growth, but also being able to pay more wages, which allowed the living standards to improve. China successfully moved hundreds of millions of people in a very short amount of time out of poverty, low-income status into considered an upper middle-income country. A lot of fixed asset investments, both in terms of residential property as well as building factories. And that I guess is where the Achilles heel resides – a lot of leverage was used to sort of turbocharge this growth. And so this is where we’ve reached the limits of what China can do with the old business model. Urbanization is largely played out. It’s unlikely that China’s going to continue to gain global market share in manufacturing. And so China needs to evolve and change, and, of course, has to deal with innovation, the leverage issue.

So, what is it that China needs to do? It needs to follow the path of Korea and Taiwan. It needs to innovate. In order to go break out of the middle-income trap, it needs to penetrate innovation throughout the economy and needs to leverage off its very favorable ecosystem. An enormous number of STEM graduates – Science, Technology, Engineering, and Mathematics – enormous potential to bring back Chinese scientists and Chinese entrepreneurs from the West. All of this – and variable government policies on pushing this evolution – all of this means that China can be well positioned to make that move. We obviously have to pay very close attention to the role the Chinese Communist Party will have in helping, directing, and evolving the private sector. That’s a legitimate question. Clearly, Xi Jinping thoughts that state-owned enterprises should play a very large role, so there are legitimate question marks on his third term about the role of the private sector, but certainly, China has all the ingredients to be able to drive innovation, a very successful innovation, a great number of patents. A lot of the key ingredients are there for China to evolve into the next stage of its growth, but we still have some legitimate question marks in terms of the role of government in that.

Hetts: Then on that note of innovation, let’s just follow that thread and bring you into the conversation, Matt. So I know that innovation’s one of the key themes that your team’s focused on, maybe even the biggest theme, but so let’s introduce the innovation theme a bit and talk about how it’s poised to become so important for emerging markets.

Culley: It’s funny because EM really does get a bad rap, because if you look at the past 10 years, it’s been really hard to keep up with the US equity returns, but it hasn’t always been that way. If you look back a little bit further from 2000 to 2010, S&P returns were essentially flat, actually slightly negative, while EM actually returned about 160%. So EM hasn’t always struggled like it has over the course of the last 10 years, but a lot of that just has to do with the strength of the US equity returns. And so I think if you look at what’s driven US equity returns over the last 10 years, a lot of it really has been innovation. I would characterize the biggest returns as coming from companies who were creating and leveraging IP, so Microsoft, Amazon, Netflix, Nvidia; we’ve all seen stats about how 90% of the S&P 500 assets now are intangible assets. But in general, we could say that innovation has been a huge driver of those returns. And I think that one of the critical building blocks has just been the expansion in access and use of information – that’s not just data, but information more broadly. It’s not just about the power of the Internet, but I think that that’s actually one of the key drivers behind it.

So if we think back to 2000, one of the key reasons why things failed to play out as expected is that we simply didn’t have the infrastructure in place to execute on the dreams of the entrepreneurs from the late ‘90s. We’re really 10 years behind the developed world. Interestingly, if you look at the constituents of the EM index today and you plot it against Internet penetration, in 2010, we were only around 40% or so. Again, that’s where the US was in 2000. Today that’s 76; again, that’s where the US was in 2010. So we’re really at the turning point here where we finally have the intellectual infrastructure in place for innovation. Then when you add on demographics, it’s where that sheer numbers and compounding really comes in. We have a lower median age, so, again, the world’s largest digitally native population of people who are accustomed to new technology. But also, US Internet penetration back then about only about 40%; it was AOL saying, “You’ve got mail.” But it wasn’t until 2008 that US Internet penetration got closer to 75%, that we had the introduction of the iPhone, everyone got on Amazon, started selling this thing called cloud software, and obviously, the rest is history, and we’ve seen what’s happened.

So if you kind of then just pivot over to EM, they’re really educated. So India alone has four times more STEM students – that’s science, technology, engineering, and math. China has five times, and if you put the rest of EM Asia together, you get another US. So you have the digital and intellectual infrastructure there in place for that demographic advantage to compound. So what is that translating into? If you look at total R&D spend globally, around 80% or so comes from the top 10 countries in the world; five of those are actually in EM now, three of the top six, so China, India, and Korea. But within that though, DM actually only outspends emerging markets by about 20%, but we’ve actually been growing much, much faster. In places like India, we still have substantial room to grow to even get close to global averages here. So the point that I’m trying to make here is that investment behind intellectual capital has historically been reserved only for developed markets, but we’re really getting to a point where this is equalizing, and it could really have profound shifts in where innovation comes from, and what the drivers of asset class returns are.

Hetts: I think that’s a great way to frame it out as far as EM being about a decade behind the US according to those different metrics you’re talking about. So then if you think about innovation in EM versus DM, I guess I’m thinking about rewinding the clock 12 years ago, and I have a time machine on my investment account, you’re looking at the big data, all the advertising revenue, and the trillions of dollars that were made by those big tech names that you talked about a little bit earlier. So then how is innovation in EM going to be different in the next decade than it was in the last decade in DM? Is it the same kind of trajectory, or does it look like a different focus for your team?

Culley: Yes, and I think that’s a great point. So, not only will we see the same and similar trends as to what we saw in developed markets, but one of the key differences in emerging markets is just how inclusionary innovation can be. So, historically, existing institutions in EM, they really underserved the vast majority of the population. So if you just take a look at the access to healthcare, if you look at the places in the world today where you see the highest prevalence of catastrophic healthcare expenditure, these almost always sit in emerging or frontier markets. But things like telemedicine, e-pharmacy …. those can dramatically increase consumers’ access to basic healthcare needs, and also drive positive health and economic benefits. One of my favorite stats is actually, in Mexico, 60% of people, six zero, are unbanked, so they are entirely outside of the formal financial sector. Why? Because banking incumbents, they’re really only set up to cater to the top portion of the retail market. They charge high fees, high-interest rates … they really have no understanding of credit underwriting to the majority of the population. So Mexico’s financial inclusion is 20% below that of countries with similar economic conditions. What solves that? It’s fintech, it’s digital banking, it’s new and innovative ways to provide services to the people who need it the most. So what I’m talking about here is, this is entirely new addressable markets. This isn’t just about taking a share of a finite pie; it’s about growing that pie. It’s about broadening the scope of who can participate in the healthcare, and financial system, and providing goods and services to those regions in really entirely new ways. Most companies in emerging markets weren’t set up to cater to anywhere close to the bottom of the pyramid, and even many cases, not even the middle, but innovation is now unlocking that as a business potential, which is what we think is really exciting, especially because it’s happening right now.

Hetts: So whether it’s then fintech or healthcare or the local Amazons that you mentioned, as far as growing that pie, Matt, can you give us some company examples of where you’re seeing this happening today?

Culley: That’s a good idea. Let’s just stick on Latin America there and focus on financial inclusion. So if we look at banks, what we were talking about before, there are really four things that a bank needs to compete on. It’s the cost to acquire those new customers, and typically this is just opening new bank branches in, let’s call it rural Mexico. Two, it’s the cost to service those customers, and that comes down to running those bank branches, what that costs. It’s the cost of risk, and again that’s the ability to properly underwrite, credit underwrite consumers at all the various different parts of the financial pyramid. And lastly, it’s the cost of funding that credit. Obviously, a bank takes deposits, and it’s their ability to substantially … to lend that out at substantially higher rates. Historically, if you look at EM, there’s a lot of survivorship bias given crises in EM, where the best banks were the ones that had the tightest underwriting standards, and they had the biggest branch networks. What we’re seeing today is companies that are kind of shifting the entire paradigm there, and they’re focusing on leveraging native technology stacks and behavioral data to beat incumbents across all four of those metrics. So as legacy banks are straddled with what used to be their core advantage, are now high-cost legacy bank branches with data and information that’s trapped across multiple siloed divisions. And if anyone’s ever worked for a big company, you know exactly what we’re talking about here. But these digital banks are really enabling broader access to financial services and doing so in a disciplined manner.

I think I also mentioned healthcare earlier, and what we’re really starting to see now is the prevalence of homegrown technologies that are being access to healthcare to more people. So a good example is in China, colorectal cancer is one of the most prevalent forms of cancer, 300,000 people get diagnosed every year, but there’s like 800 million people who are at risk. So the worst part about this is that only 6% of them actually get diagnosed at Stage I. And why is that? Because historically the only way to screen for it is an expensive and invasive coloscopy, but only 30% of hospitals in China can actually even provide a colonoscopy. So today we’re seeing companies bringing noninvasive solutions to the market, they’re highly accurate, they cost $150. And what’s incredibly exciting is that it’s not just companies that are in Phase 1 and Phase 2 trials, these are companies that have completed Phase 3 testing and are into commercial deployment. So that’s what today driving the inclusion that I talked about earlier, and again, driving a whole new addressable market that really didn’t exist before.

Hetts: That’s great, thanks, Matt. And then another megatrend for you to hit on would be ESG, sustainable investing, and, Daniel, maybe back to you on this one. So how does ESG or sustainable investing fit into emerging markets? And I think continue with the contrast, how would you contrast EM investing versus DM investing from a sustainable or ESG perspective?

Graña: Of course, we call it GES in our emerging market team, because we place governance first. You have to understand that the overwhelming majority of companies in EM have controlling shareholders, either family or the state. There are very few companies that have a completely fragmented shareholder registry, so you really have to appreciate what the controlling shareholder wants to do, how they treat minority shareholders, related party transactions, and all the kinds of corporate governance things. You have to accept that, investing in emerging markets, that business practices, acceptable business practices, is very different. But it’s more than just corporate governance, it’s also political governance. What kind of political environment are these companies swimming in? And so you have to put governance first when investing in EM. Now, Matt talked about innovation in EM, what gets us so excited about this new pillar is that it solves so many of the EM old inequities in financial services, healthcare, and the consumer experience. So innovation is a way of solving the E and S problems in emerging markets. So investing in ESG is not just about looking for companies that have an independent board of directors, not just about those companies that are making a difference in a developed market sense. In EM you have to respect and understand the rules of the road are different, therefore governance first. But also that these companies really do solve the E and the S problems in EM and therefore makes EM very much a candidate for ESG investing.

Hetts: Great. That wraps it up. A big thanks to Danial and Matt for the update, and thanks to our listeners for joining. If you haven’t already, you can find more Global Perspectives on Spotify or iTunes, or wherever else you listen. And, of course, check out the Insights section of the Janus Henderson website for more of our views. Thanks again. We’ll see you next time.

Originally Posted January 19, 2023 – Global Perspectives: Charting the trajectory of innovation in emerging markets


Environmental, social, and governance (“ESG”) factors are integrated into the investment process by focusing on those ESG factors considered most likely to have a material impact on the financial performance of the issuers. ESG factors are one of many considerations in the investment decision-making process and may not be determinative in deciding to include or exclude an investment.

Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.


DM refers to Developed Markets.

WTO refers to World Trade Organisations.

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