The investible emerging markets equity universe has experienced a seismic shift over the last decade: major markets have moved from being very globally-exposed and cyclical to more of a mix of global information technology and local consumer-driven stocks. This has clear implications for the changing risks that drive emerging markets investors’ returns, of course. But it should also encourage us to think again about how emerging markets are valued—relative to developed markets, but also relative to their own history. Emerging markets may not be as expensive, or as cyclical, as one might think.

From commodities to computers

The shift in the investable markets has resulted in a shift in the MSCI Emerging Markets Index. At the end of 2007, energy (18%) and materials (15%) accounted fully for one-third of the index. Fast-forward to 2017, and those two sectors account for only 14%. Information technology has risen from 10% of the index to 28%, partly through faster growth and partly because MSCI included China’s predominantly technology focused American Depositary Receipts (ADRs) in the index during 2015-16. Commodity-driven markets such as Russia and Brazil have declined as a proportion of the index, while China, increasingly represented by internet software and services stocks, has grown. At the end of 2007, China accounted for 16% of the index, and Chinese tech companies 0.3%; by 2017 China had a 30% allocation and China tech accounted for 12.3% of the index.

The shift to information technology in the investable markets better reflects the “real” economy and consumer behavior within it, both now and especially in the future. But how should one value emerging markets, given this radical change?

A changing profile implies changing views on valuation

We might expect the MSCI Emerging Markets Index to have become less attractive on a valuation basis, relative to both its history and to the valuation in developed markets.

In fact, the MSCI Emerging Market Index not only trades at a lower price-to-equity ratio than the MSCI World and S&P 500 Indexes, it has also been getting relatively cheaper for the past six years, even as its exposure to the technology sector has grown.

Broad technology-sector valuations are in the middle of their own 10-year historical range. Valuations in internet stocks are rich, but the hardware and semiconductor industries are trading cheaply relative to their history, probably due to the past boom-and-bust cycles in these sectors. We would argue that these companies should not all be painted with a broad brush, however, as certain sub-segments are benefitting from an entirely new theme of technology and semiconductor proliferation in autos and other appliances.

Compare the U.S and emerging markets energy, material and technology sectors using price-to-earnings ratios and estimated five-year earnings-per-share growth, and the picture becomes even clearer. First, the three Emerging Markets sectors trade more cheaply relative to their US counterparts. Second, outside of U.S. energy, which is coming off a lower earnings base, they also have stronger earnings growth. When we go back up to the index level again, we can see this dynamic playing out in price-to-earnings growth ratios: in developed markets, this ratio sits at around 1.5, whereas in emerging markets it is less than 0.8. Technology stocks in the emerging markets are cheaper, even though their earnings are growing faster.

Strong Growth Is Not Without Risk

This dramatic change in emerging markets does come with an element of concentration risk: the top four holdings in the MSCI Emerging Market Index are all technology firms—and the fifth has a 30% stake in the first. Together, they account for nearly 20% of the index. The top five stocks in the S&P 500 Index are also dominated by technology today, but by contrast they account for only 12% of the index. Having said that, the sector as a whole accounts for 28% of the MSCI Emerging Markets Index, versus 26% of the S&P 500: while concentration has increased we do not believe it is out of sync with other markets.

We view emerging markets as an attractive investment opportunity, especially on a relative-value basis. We like the superior growth characteristics of technology, and we would argue that, with earnings growth led by sectors that are not solely dependent on the global economic cycle and global trade dynamics, emerging markets exhibit a very different profile now than they have had in the latter stages of previous global cycles.

Conrad Saldana is Senior Portfolio Manager — Emerging Markets Equity at Neuberger Berman which is a member of The Gulf Capital Market Association.