Jasmine Birtles
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Investing in emerging markets: Opportunities & challenges to consider
Karl
10th Mar 2023
If you’re an investor seeking above-average returns, investing in emerging markets could be for you.
Big returns are certainly possible if you put your faith in developing nations. However, the flip side is that emerging economies are notoriously unpredictable, and can easily leave investors in the red.
In this article we’re going to explain everything you need to know about investing in emerging markets. Keep on reading for all of the details, or click on a link to head straight to a section…
Investing in emerging markets: what does it mean?
Investing in emerging markets is a way for investors to tap into the potential of economies that are still developing, but are on the path to becoming fully developed.
A country that is emerging will typically have an economy that is developing at a fast pace, especially in relation to other countries with similar sized populations.
Rationally, all countries with emerging market status should have the desire to become fully developed. That’s because as countries develop, their respective economies will have a bigger role to play in global affairs. On top of this, living standards rise when economies become more advanced.
emerging economies vs developed economies
Developed nations – such as the UK – typically have open, market-based economies where high household incomes are the norm. Developed countries also enjoy high standards of living, established infrastructure, and mature capital markets.
In contrast, emerging countries are more likely to be industrialising and have closed economies. Household earnings and living standards in developing nations are also lower than developed nations, while capital markets are typically less mature and more volatile.
Aside from the above, a major difference between developed and developing countries is that, in developed nations, economic growth is often slow and stable. In contrast, economic growth in emerging nations can often be rapid.
Examples of emerging markets
When you think of emerging markets, the BRIC countries may be the first thing (or acronym) that comes to mind.
BRIC refers to Brazil, Russia, India and China. These countries were considered to have economies set to make them ‘rising economic powers’. We’re using the past tense here as Russia’s status as a successful emerging market is now very much disputed. Western Citizens can no longer access Russia’s economy following the Ukraine war of course.
Some other countries considered by many to be in their development phase include:
- Malaysia
- Mexico
- Morocco
- Philippines
- Poland
- Taiwan
- Thailand
In addition to the above, we also shouldn’t forget the CIVETS countries. This includes Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa. These countries are all predicted to experience rapid economic growth over the coming years..
why are investors sometimes drawn to emerging markets?
Investing in countries experiencing speedy economic growth provides an opportunity to earn significant financial rewards. This is arguably the main and most obvious reason why many investors are drawn to emerging markets.
For instance, the MSCI Emerging Markets Index – an index that contains a mix of stocks in fast-growing nations – returned 18.3% in 2020. And while the index hasn’t always been in the green – it reported losses in 2021 and 2022 – in the 35 year period between December 1987 and January 2023 it achieved an average annual return of 10.2%.
Another reason why investors may be keen to to invest in emerging markets is the fact the performance of emerging countries can be influenced by a number of different domestic factors, such as education standards, the political situation, and general infrastructure.
Likewise, the performance of emerging markets can also be influenced by external factors, such as global demand for a particular technology or commodity. For example, if a developing country is heavily reliant in mining a particular commodity but global demand falls, then this is likely to have a big impact on its domestic economy. On a similar note, if an emerging economy transitions from an autocratic political situation to a democracy, then this can boost its overall attractiveness for foreign investment.
Because of the high number of variables involved, for active investors who enjoy picking stocks and carefully undertaking research, investing in emerging markets can be one of the most interesting ways to invest. This is another reason why emerging markets can be particularity attractive to investors.
what are the risks?
Any informed investor will tell you an opportunity for big gains is also an opportunity for big losses.
Emerging economies can be very unpredictable to say the least, and this is why returns are often volatile. As covered above, one of the reasons for this is the fact that external factors can impact the performance of emerging markets. For example, if an individual country suffers political instability, currency volatility, and/or regulatory uncertainty, then these can all have a negative impact its economy.
Ultimately, investors who decide to invest in emerging markets must accept the risk that a lot of these variables will be totally out of their control. Just ask investors who had interests in Russia prior to the Ukraine war, or investors who put their faith in Venezuela prior to its 2014 economic collapse.
Despite the risk of losses, however, investors can minimise the risk of their investments plummeting by investing in emerging markets as part of a well-diversified portfolio.
How to invest in emerging markets
Investing in emerging markets certainly carries a high degree of risk. Despite this, it is easy to see how some investors are attracted to developing nations because of the potential for big gains.
So, if you’re interested in chasing above-average returns, you have a strong stomach for volatility and you understand the risks, you may be wondering how you can gain exposure to emerging markets.
Well… there are actually two ways you can go about it. You can either buy shares in individual firms, or buy an exchange-traded find. Let’s take a closer look at these options:
1. Buying shares in individual firms
Buying shares in individual firms based in developing nations is arguably the most obvious way to gain exposure to emerging markets. For example, if you’ve faith in the Brazilian economy, then you may wish to buy shares in a major soybean producer based in Brazil. On a similar note, if you’ve fell the Indonesia technology sector has further room to grow, then you may wish to buy shares in a microchip firm based in the region.
Do note, however, that buying shares in a single country or region is riskier than buying shares in multiple firms. That’s because if you buy shares in firms around the world, you’ll be less likely to be impacted should a single country or region experience an unforeseen event. For example, an economic shock or natural disaster.
It’s also worth knowing that to invest in firms listed on stock exchanges based in emerging markets you’ll have to do your own research to understand the ins and outs of an overseas stock market and, potentially, any relevant tax obligations. Investing in UK-listed stocks heavily involved in emerging markets is one way investors can swerve these challenges. For example, UK-listed giants, Unilever and Diageo make 40%-60% of their sales in emerging markets. So, investing in either of these companies would allow UK-based investors to gain some exposure to emerging markets, without the need to get to grips with an overseas stock exchange.
2. Buy an exchange-traded fund
One of the easiest ways to gain exposure to lots of companies is to buy a an exchange-traded fund (ETF). Here are some ETFs that provide exposure to emerging economies around the world:
- iShares MSCI Emerging Markets ETF
- Vanguard FTSE Emerging Markets ETF
- Schwab Emerging Markets Equity ETF
If you want exposure to a particular region, then these are some ETFs that target specific regions:
- iShares MSCI India ETF
- MSCI Brazil ETF
- MSCI South Africa ETF
To learn more about gaining exposure to multiple firms, take a look at our step-by-step-guide to exchange-traded funds. Also, if you’re interested in learning more about investing, why not sign up for our free fortnightly MoneyMagpie Investing Newsletter? It’s free and you can unsubscribe at any time.
Disclaimer: MoneyMagpie is not a licensed financial advisor. Information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This isn’t financial advice. Anyone thinking of investing should conduct their own due diligence.
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