Investing in emerging markets

09 December 2016

Investing in emerging markets can be a rollercoaster ride. We explain what you need to know.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

What you’ll learn:

  • What emerging markets are
  • What the main attractions of the asset class are
  • Which risks you need to consider

The defining characteristic of emerging markets is that their economies are still very much in the development phase. Unlike more advanced nations such as the UK and the US, they typically boast very young populations, a rising middle class and some, but by no means all, are enjoying robust levels of economic growth and industrialization.

The International Monetary Fund anticipates that emerging markets, as a whole, will experience economic growth of 4.2% this year, compared to just 1.6% for the developed world.1

But while investing in emerging markets may have so far proved to be a winning strategy in 2016, the same cannot be said for previous years, as the sector has experienced multiple years of underperformance. Such volatility is part and parcel of investing in this asset class.

Nonetheless, many experts argue that the long-term case for investing remains intact, mainly because of the compelling demographics associated with emerging markets.

Take the nations of Brazil, Russia, India and China, otherwise known as the BRICs, a term which was coined by former Goldman Sachs Asset Management chief economist, Jim O’Neill in 2001.2

Together these nations account for some 40% of the world’s population and between them carry a wealth of natural resources. It is widely expected that as their respective economies expand, so too will their levels of consumer spending. It has been predicted that by 2025, annual consumption in emerging markets will reach an eye-watering $30 trillion, which should help companies prosper and hopefully deliver better returns to investors.3

The inherent risks

Despite the attractive demographic backdrop, emerging markets are often beset by political instability, poor regulation and corruption. Just recently Brazilian President Dilma Rousseff was ejected from her office by the country’s senate following an impeachment trial.4

The upshot of this is that emerging market stock markets can be highly volatile and sensitive to any negative news.

Find out more about understanding risk and return

A recent example of this was when China’s central bank, the People’s Bank of China, unexpectedly decided to devalue the yuan in 2015, sending markets into free-fall.5

Pressures on commodity prices can also have a significant impact on emerging markets. For example, while the low oil price in 2016 has proved to be a boon for net importers such as China, its time in the doldrums has been catastrophic for exporters such as Venezuela, Russia and Brazil.

Emerging markets can be particularly sensitive to political risk too. The value of the Mexican peso, for example, had an inverse relationship with Donald Trump’s success in the US presidential race. When the polls showed the Republican’s stock rising with the electorate, the currency plummeted in value and vice versa.6

Developed world influence

Developing economies are widely influenced by what happens elsewhere in the world. While China’s slowing economy spooked investors early in 2016, the situation was exacerbated by the US Federal Reserve’s decision to raise interest rates last December.

Steeper borrowing costs in the US, coupled with a stronger dollar, never bodes well for the sector, especially for natural resources-reliant nations, as commodities are largely priced in the greenback, and are therefore negatively affected by the more expensive currency. In addition, given that the majority of developing market companies generally borrow in US dollars, an increase in its value means greater debt levels.

What you need to consider

Given the variety of factors that influence stock markets in the developing world, it is vital investors take a long-term view. While most experts typically recommend that you should have a time-horizon of at least five years, for emerging markets, investors may need to buckle up for far longer.

Always remember that a sensible investment strategy means maintaining a suitably diversified portfolio so that you are not dependent on the success of one single investment or sector.

Find out more about diversifying your investments

It’s also a good idea to regularly review your portfolio to make sure you aren’t overweight in one particular area. For example, say you had 10% of your portfolio in emerging markets, and over a 12-month period this sector enjoys a sustained period of gains while your other investments have under-performed, you will end up with a lot more of your cash in emerging markets than you began with.

If you have emerging markets exposure, now might be the time to look at perhaps banking some profits and/or rebalancing your investment portfolio by taking some of that money and re-investing it in regions and assets which haven’t performed as well. If you are unsure about how to proceed, seek professional financial advice.

Remember too that when it comes to investing overseas, you need to take currency risk into account. If the pound weakens, this will boost your returns from foreign investments. However, if sterling starts to strengthen the opposite will happen.

But no matter how effectively you diversify your investments, remember that they can still fall in value so you may get back less than you invest.

Investors should bear in mind that our referring to these markets and assets does not constitute advice or a personal recommendation to invest in these or any other investment.

If you’re unsure about whether investing is right for you, seek independent advice.

Please bear in mind that this article is for general information purposes only. If you are unsure, seek professional independent advice.

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