Rising Strong: Emerging Market Companies Adapt to Thrive

In the penultimate action scene in the film, ‘The Grey Man’, the hero faces almost certain death calmly, telling his young companion that defying impossible odds and delivering justice ‘is just another Thursday.’ Emerging market companies are themselves facing what they might describe as ‘just another Thursday’ in the form of potentially significant new US tariffs from the Trump 2.0 administration.

As a group, EM companies are well practiced at survival and adaptation. One of their key manoeuvres is to cut leverage during tough conditions. Leverage for EM High Yield (HY) companies, on average, is at similar levels to Developed Market (DM) investment grade (IG) leverage and EM IG is even lower.

During the first Trump presidency, EM companies faced their first set of tariffs, as well as lower oil, weak global growth – notably from China – and a large corruption scandal in Brazil. Nonetheless, leverage declined from 2016 to 2019, leaving EM companies well positioned for the next challenge: Covid, where they demonstrated great resilience.

Since then, despite higher interest rates, geopolitical conflict, macro-economic uncertainty and volatile commodity prices, EM companies have reported several years of flat to lower leverage and decent profits. This strength is finally being recognised with net positive rating upgrades, many independent of the sovereign rating of the country where they are based, this year. High defaults and downgrades in specific sectors have purged weaker credits, most dramatically in China real estate in 2022-2023. The majority of EM sovereign ratings are expected to be stable into 2025, providing additional support. EM companies are looking ahead to a year of reasonable economic growth, even considering potential tariff impacts. We forecast respectable emerging market growth ex-China of 3.4% in 2025, albeit China growth remains relatively low at 4.5% relative to its official target of around 5%.

Another advantage is that few EM companies have direct exposure to potential US tariffs via exports to the US. We reviewed over 600 companies under our coverage and found only 16 generate more than 25% of revenue from US exports. These are primarily auto manufacturers (Kia, Hyundai) and technology companies. The auto companies tend to use Mexico based plants protected by NAFTA’s successor USMCA. Others, such as Honhai, export to the US as part of their supply agreement with US based companies such as Apple, which may adjust US pricing to compensate.

The same applies to China, which is only 6.5% of the CEMBI Broad Diversified. This has reduced from 8.2% in 2016. We studied the geographic revenue split for 494 companies in the CEMBI, a subset of the total 745 companies in the index. Looking at this group, only 23% have with material exposure (20% of revenues or more) to China. They are primarily domestic companies or diversified companies with significant operations in China.

As emerging markets have grown, they have produced their own domestic champions. Well over half of the CEMBI BD Index is comprised of domestically focused industries such as utilities, banks, real estate, telecoms and infrastructure. These companies are less exposed to global macro shocks and, given the breadth of sectors across many countries, provide a good way to diversify risk. Despite the common perception that EM companies are a proxy for commodities, less than 20% of the index is made up of commodity producers (Oil and Gas, Metals & Mining, Pulp and Paper.) This index diversity allows active investment managers to filter opportunities to focus on companies with true competitive advantages.

2025 will undoubtedly deliver surprises. EM companies remain well equipped to manage. Historically, they have delivered solid positive returns across different presidential terms. While this market has performed well in 2024, risk adjusted spreads remain attractive. Any volatility would create a good opportunity to add.

¹ Sampling the largest EM economies that comprise roughly 75% of all EMs (GDP weighted).

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