Investing in an Emerging World Order. Part 1
In the first installment of our three-part series on global supply chains, Portfolio Managers Peeyush Mittal and Inbok Song discuss why and where trading networks and manufacturing hubs are changing and how it’s impacting the international investment landscape.
- In the pre-pandemic world, profit motive and ‘just-in-time’ classical economics were often the decisive drivers for companies, helping to fuel a massive globalization movement aided by low interest rates.
- The pandemic, war, inflation and geopolitics have since disrupted and rattled supply chains around the world. Political tensions have also incentivized companies to rethink their relations with and reliance on China.
- Amid these changes, certain emerging markets like India, Vietnam, Mexico and the Philippines have become key destinations for companies. Other markets like South Korea and Taiwan are reshaping their supply chains to diversify and navigate geopolitical strains between the U.S. and China.
The world today—characterized by a surprisingly robust U.S. economy, high interest rates and geopolitical tensions, and sweetened with pockets of exuberance like artificial intelligence—can be challenging to decipher.
One way to try and understand it is through the considerable changes occurring in global supply chains: those markets and companies that have moved rapidly into the electric vehicle (EV) and renewable space; those that have seized opportunities resulting from U.S. sanctions on China’s tech and semiconductor industries; and those markets that are increasingly offering production alternatives as companies navigate changing commodity and operational costs and geopolitics. These moves are popularly (and variously) described as offshoring, nearshoring, reshoring and de-risking.
In this series, we look at the emergence of these trends, their potentially lasting impact and what they mean for investors.
Prior to the pandemic, many companies and economies tended to see their supply chains through a classical economics lens. It was an era of hyper-globalization propelled by innovation, China’s economic rise and low U.S. interest rates. Profit motive was often the prime economic decision-maker with supply-chain dynamics based on the just-in-time model whereby companies sourced components and raw materials according to flexibility and speed. Now, in addition to these traditional variables, security and location (including proximity to headquarters) have become key considerations.
One common element in the supply-chain changes we are seeing is China. In recent years, several factors have worked to raise awareness of China’s dominance in many areas of trade. First, there was Brexit and the Trump administration’s tariff policy; then, the pandemic effectively halted global trade, starving the world of China’s goods and triggering inflation. Finally, as we emerged from the pandemic, supply-chain problems and escalating geopolitical tensions between the U.S. and China added to an increasing recognition among corporates that exposure to China was worthy of review.
China itself has also contributed to moves by some companies to rethink their trade and supply chains with the country. China’s regulatory interventions have created headaches for domestic and international companies, compounded by its ongoing economic efforts to recover from its extended zero-COVID policy.
One other general trend affecting supply chains is an increased focus on sustainable and environmental considerations, which has incentivized companies to reexamine supply chains to determine whether there are more optimal means of organizing them. For example, companies may opt to source raw materials or intermediate goods from markets where they are sustainably produced. Or they may start to source from, or manufacture in, markets where workers are better treated.
“Supply chains are being loosened as companies look for ways to shift production or other business units. Relocating operations is heavily influenced by a multitude of factors ranging from cost, proximity to market, government incentives and geopolitics.”
New production hubs
All of these factors have played a central role in supply-chain reassessments. So how is it playing out on the ground? Some companies are partially relocating production overseas from their domestic markets, whether to emerging markets economies or developed economies. In China, more companies are relocating or building new operations overseas to mitigate geopolitical frictions and reduce labor costs. In other instances, multinational companies are choosing to pursue a so-called China Plus One strategy whereby they maintain existing production facilities in China but open new factories in other emerging markets.
And as multinational companies look to reduce or manage their China presence, emerging markets like India, Mexico, Vietnam, Cambodia and the Philippines are seeking to attract their business. In India, the government is incentivizing companies to set up in the country partly with its program to cut red tape and bureaucracy. Mexico, on the other hand, is appealing due to its proximity to the U.S. consumer market and trade pact with the U.S. and Canada. In Mexico, Mattel, the maker of Barbie dolls, now has its largest manufacturing hub. Then there is the technology and semiconductor manufacturing industry, much of which is based in Taiwan and South Korea and is currently enjoying the nascent AI boom.
These are just a few illustrations of the supply-chain dynamics that are occurring and will accelerate or slow according to the global economy’s changing momentum. While established supply chains aren’t defunct by any means, in many areas they are being loosened as companies look for ways to shift production or other business units. And the operational destinations are being heavily influenced by a multitude of factors ranging from cost to regulation, government subsidies and incentives.
In the second part of our series, we’ll explore a few of the regions and countries where we are seeing some of these impacts and how we think they might benefit and offer investment opportunities.
Sifting Through the Shifts
-Offshoring, nearshoring and attractive EM locations
-De-risking and reshoring
-Pivoting and strengthening links in the chain