3 April 2020
The impacts of COVID-19 will vary from country to country depending on the policy response to the virus itself as well as the fiscal/monetary support that can be provided by that country to support economies through the virus.
Significantly, though, most countries have now enacted some form of fiscal and/or monetary policy response. Collectively, these policy actions amount to powerful economic stimulus – both in country and on a global basis. While they will take a while to gain traction, once they do their impact will be significant in balancing the global economic downturn which looks likely to emerge over the coming months.
In terms of specific policy responses, China led the charge with mass quarantine and closures, and to a large degree now has control over the contagion. The January/February shutdown will have economic ramifications, but China is in a position to offer significant further stimulus in an economy that was already being supported by the emerging middle class. Data points emerging from China show that production and demand is getting back on track.
As the virus takes hold across the globe, these policy responses will go a long way to determine how individual countries work through the medical emergency. As a rule, healthcare in emerging markets (EMs) is not as sophisticated as their developed peers, and this could prove an issue – as could community living and lower overall hygiene standards. However, at the same time the EMs generally have younger populations, with less elderly people who are more susceptible to the virus.
From an economic standpoint, some of the EM economies are in a strong position to support a weaker economy (e.g. China) while others are less able (e.g. Argentina), and this also holds true for developed economies (e.g. USA vs Italy).
No EMs have been immune through this crisis. Fundamentally, however, we believe a lot of infrastructure names (particularly utilities, which are somewhat immune to economic cycles) are holding up well, and there will be a significant opportunity in this space in the nearer term. However, the more economically sensitive stocks have also been oversold, and when the bulk of the globe can get on top of the virus we expect a fast and significant re-rating towards fair value.
China has held up better than some of its peers, as (unlike many others) they appear to have managed the COVID-19 contagion and are coming out the other side, with borders opening and work and life returning to normal. Before this outbreak, we were big believers in China for 2020 with the first phase of the trade deal done and domestic consumption ramping up. While we expect the virus to have softened economic activity in the short term, we do anticipate China will bounce back remarkably quickly, with support from the government where needed.
Within the infrastructure space we think every market is currently under-valued, and this volatility will represent a significant buying opportunity. Infrastructure is known as a defensive asset class and, despite the recent market moves to the contrary, it remains so. Earnings are underpinned by real assets, supported by regulation and contracts with monopolistic market positions – and because of its defensive characteristics, infrastructure offers long-term visible and resilient earnings streams. As such, when market volatility dissipates we expect these assets to re-rate quickly as the valuations prove to be very attractive.
If you factor in the emergence of the middle class and the domestic demand story, the value of infrastructure in EMs at the moment becomes even clearer. Infrastructure offers basic essential services (clean water, waste treatment, electricity) and improvements to quality of life (roads, logistics chains), so is an early winner of the middle-class evolution.
There are assets within infrastructure that will suffer a fundamental near-term earnings shock as a result of the virus (e.g. airports, toll roads and user pay assets in general). However, these assets remain long dated, many of them have strong balance sheets (no credit shock), and historical events prove that travel plans are often delayed during 'events' such as these rather than cancelled, which should see a strong rebound once travel restrictions are eased.
Within our global portfolio we remain overweight the emerging markets. Within EMs, our key exposures include China, Indonesia, Brazil and Mexico, which are geared to the emergence of the middle class and the domestic demand story. In the near term we are moving more overweight to utilities as they are a net winner in a low commodity, low interest rate, restricted travel environment. However, we retain exposure to completely oversold economically sensitive infrastructure stocks such as toll roads and airports, where we expect a strong rebound once the curve turns on COVID-19. We are long-term value investors, and are using this market volatility to position ourselves with the best mix of quality and value within the infrastructure sector.
ESG has always been a significant part of our investment process. Whether a stock is in a developed or emerging market, it must meet our ESG criteria at both a country level and a corporate/stock level before we look to invest. Within EMs, at the country level this includes looking at things like the strength of a country’s judiciary system, the political environment, environmental targets, social policies, and demographic trends such as an ageing population or wealth equality. Importantly, within the EMs we are definitely seeing countries work toward better ESG standards – and subsequently, companies tend to follow suit.
The global equity market is offering opportunity right now, particularly for infrastructure investors globally, which includes emerging markets. EMs came into this downturn relatively undervalued and with thematics supportive of the long-term opportunity set. As infrastructure investors, we remain excited about the emergence of the middle class in developing economies where infrastructure is needed to drive the evolution. We believe that once investors regain some confidence in the market, infrastructure (including EMs) should benefit as it is now attractively positioned from a fundamental quality and value perspective.
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