What’s in a name?
We explore what makes an emerging market and why they can offer attractive investment opportunities.
For example, South Korea is one of the world’s largest and wealthiest nations. Its GDP per capita – which measures economic output divided by total population – was $31,846 in 2019, outranking countries like Spain, which had a GDP per capita of $29,600. Yet South Korea is still classed as an emerging market in many stock market indices, such as the MSCI Emerging Markets Index. So why does the country fall into this category?
Markets have to meet specific criteria to be included in an index based on factors like their size and how easy it is to buy and sell securities. In investing terms, South Korea is not currently considered to be as accessible as its developed market counterparts. While its economy may be stronger than those of some developed markets, its financial markets are less efficient.
In short, financial markets in developing countries are less mature than those in developed countries. This means it’s often difficult to obtain information about companies listed on their stock markets and it may not be as easy to buy and sell shares.
Why invest in emerging markets?
In general, emerging markets appeal to many investors because they offer the potential for relatively high returns – but this comes with greater risk. One benefit is that economies that fall into this category usually experience faster growth than that seen in developed markets.
For example, the economic growth of most developed countries, such as the US, Germany and Japan was less than 3% in 2019. On the other hand, the economies of emerging markets like Egypt, Poland, India and Malaysia expanded by 4%. China, which is also in this category, experienced growth of around 6%.
Many of these countries follow an export-driven strategy due to a lack of domestic demand. This means they produce low-cost consumer goods and raw materials to export to developed markets, driving economic growth and boosting investor returns.
What are the risks?
While emerging markets do offer attractive investment opportunities, investors have to be willing to do the appropriate research to find them. Many of these countries experience high volatility due to natural disasters, external price shocks and government instability. In addition, they’re vulnerable to currency fluctuations, especially in relation to the US dollar.
Recent dollar weakness has been beneficial for emerging markets because the value of foreign-currency denominated assets rises for US investors as the dollar falls. In other words, imagine you’re an American tourist going overseas. When you convert your dollars into foreign currency, it won’t go as far when its value is lower. Another benefit for emerging markets is that a weaker dollar helps them pay off their US-denominated debt.
What are frontier markets?
Frontier markets are smaller, less accessible and riskier than emerging markets, but offer potential for high returns over the long term because they could grow to be much more stable over the next few decades. Examples of frontier markets include Kazakhstan, Nigeria and Sri Lanka.
Emerging markets offer a range of attractive investment opportunities, but you should also be aware of the risks involved. If you’d like to find out more about investing in emerging markets or investing in general, speak to your financial adviser.
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
Past performance is not a reliable indicator of future performance and should not be relied upon.
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