What you need to know about emerging markets

What you’ll learn:

• What emerging markets are.
• Why investing in emerging markets is riskier than investing in developed countries.
• How to gain exposure to this sector.

The world’s your oyster when it comes to investing, so you don’t have to stick to your home country when looking for opportunities.

Many investors often start out investing in the developed countries they are familiar with, such as the UK or the US, but for those with a strong constitution and more experience there are plenty of so-called ‘emerging markets’ that may offer long-term growth potential.

Here’s what you need to know.

What exactly are emerging markets?

The term ‘emerging market’ was coined by Antoine van Agtmael in 1981, an official working for the World Bank. There isn’t a universally accepted definition of what an emerging market is, but they are usually countries with economies still very much in the development phase – often with large, young populations, a rising middle class, and the potential for strong economic growth.

Countries considered to be emerging markets vary dramatically in size; from the powerhouses of India, to far smaller economies, such as Tunisia. However, they are often considered to be ‘emerging’ because of their economic development and reform programmes, and markets that are attracting global investment.

The MSCI Emerging Markets Index is a benchmark for these markets, and includes investment performance across 26 emerging market countries. These include countries in Africa, Eastern Europe, Latin America, some in the Middle East, Southeast Asia, and Russia.¹

Among some of the largest and well-known emerging markets are the BRIC countries, or Brazil, Russia, India and China. Together, these countries alone account for around 40% of the world’s population, and carry a wealth of natural resources.²

Why invest in emerging markets?

There are several reasons that emerging markets might appeal to investors.

• Growth: Emerging market economies enjoy better long-term growth prospects relative to their developed counterparts. These economies tend to have a higher rate of population growth, while being able to reap the potential benefit from long-term domestic reforms. Besides that, they still have ample room to take advantage of technological transfers from developed economies, thus helping their workforce become more productive. The emerging market companies based in these regions are best placed to benefit from these higher growth prospects.

• Valuations: While emerging market companies enjoy better long-run growth prospects, growth shouldn’t be the sole consideration here. The price you pay for buying these shares matter as well. After all, there’s little point in investing in a fast growing company if you’re overpaying for its shares. Fortunately, current valuations for emerging markets don’t look excessively overpriced, and patient investors should still be able to reap decent long-term returns at these prices.

• Diversification: When it comes to investing, it’s always important to avoid putting all of your eggs in one basket. Different assets often move in different directions. Therefore, by diversifying your investments across different asset classes and geographies, you can reduce the amount of risk in your portfolio. Investing in developed markets and having some exposure to emerging markets can help with this as you won’t be dependent on the success of one single region.

What you need to consider before investing in emerging markets

Emerging markets have, at times, been plagued by political instability, poor regulation and corruption, with stock markets that can be highly volatile and sensitive to any negative news.

For these reasons, investments in emerging markets tend to be much more volatile than those in more advanced economies, and so are more likely to fluctuate in value. They definitely aren’t for the faint-hearted and you’ll need to be comfortable accepting the fact that you could get back less than you put in.

It’s therefore vital that you take a long-term view when investing in emerging markets. 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.

When it comes to investing overseas, you’ll also 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.

Funds which invest in global emerging markets include the Investec Emerging Markets Equity Fund which aims to exploit the opportunities of emerging markets, and the Lazard Emerging Markets Fund. The Lazard fund typically invests in the shares of companies located in countries in the MSCI Emerging Markets Index, which it aims to outperform.

Investors should bear in mind that our referring to funds 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 remember that investments can fall as well as rise and you may get back less than you invested. Past performance is not a reliable indicator of future performance.