In a course of just a few years, the world investment landscape has witnessed a massive sea change. Previously unthinkable, the stock markets of small and risky emerging economies have soared, and at times even exceeded the gains secured in the U.S. and the UK, shocking many investors and experts alike.
It’s far from straightforward, however. There’s no doubt that while significant gains can still await those who pounce at the right emerging market at exactly the right time, the risks involved are pretty substantial. Investors must weigh up the danger of giving up the security of more established markets against the chance to earn good profits. In other words, you must determine whether investing in emerging markets is the right thing for you to do.
What are Emerging Markets?
First, let’s discuss what emerging markets actually are. Emerging markets are basically fast-growing nations who are in a transitional stage between developing and developed. The term “emerging” is not confined to economic strength or geographic size. Instead, a country is considered emerging because of its reforms and developments. Thus, even though China is deemed an economic powerhouse,
it’s considered an emerging market alongside Tunisia, which has a smaller economy and fewer resources. This is because both countries have only recently begun to carry out economic reforms and open their markets to the global scene.
Emerging market economies include Brazil, Russia, India, and China – collectively called the BRIC nations – as well as South Africa, Iran, Vietnam, Indonesia and many more.
Investors are traditionally looking for those markets where the social and political struggles of the country have more or less ended and where economic growth has just been triggered.
Including Emerging Markets in Your Portfolio
Emerging markets represent nations that possess high growth potential. Thus, they’re an important component of a balanced portfolio. The most common way to build them into your portfolio is through Exchange Traded Funds (ETFs). What you get with ETFs is diversification through exposure to several markets in a single security.
Because emerging markets are still in transition and are by their very nature unstable, they do carry some risks. There’s always the possibility of a few economies falling back into a revolution that perhaps wasn’t completely resolved, or of suffering from other factors that could cause their capital market to collapse. Likewise, because the risk of investments in emerging markets is higher than that in developed markets, they’re more prone to speculations, panic, and knee-jerk reactions. A good example would be the 1997 Asian Financial Crisis where international flows into such countries suddenly reversed themselves.
The Christ the Redeemer Statue overlooking the city of Rio de Janeiro in Brazil.
To Invest or Not to Invest?
So the question, therefore, is whether emerging markets offer more opportunity than risk, or whether they can still offer solid potential to the risk-averse among us. Emerging markets were touted as the next best thing not so very long ago, but further fluctuations in the markets have encouraged many investors to pull away recently.
Indeed, as of the time of this writing, emerging markets are facing inflation and growth concerns. South Africa’s inflation continues to increase mainly due to fuel and food costs. China, on the other hand, has seen stagnation in its manufacturing sector and a property market slowdown which will further raise commodity prices, thereby putting pressure on its trading partners like Brazil, Chile, and South Africa. India is also expected to experience a slowdown in terms of economic growth in the next two years.
Because of the above, emerging markets have suffered the worst pullback in the last month. Both equity and fixed income funds are experiencing significant withdrawals. However, it’s important to note that what we’re currently seeing was predicted.
Late last year and early this year, the MSCI Emerging Markets ETF prices formed a double top. According to many technical analysts, this indicates that a trend reversal is on the way. In the first quarter of this year, the upward trend from last year has waned and the index was trading sideways.
But despite the fears of inflation and massive pullback in emerging markets, investors should remain resilient. Emerging markets are expected to grow in the long run. What they’re presently going through is anticipated turbulence due to their spectacular run last year. Remember that investing in such markets requires perseverance and patience. This is why the gains are so huge for investors who can sail through the rough patches.
And because emerging markets were hit badly by redemptions, the stocks are currently “cheap” so it’s the perfect time to buy on a valuation basis. In fact, the index has fallen by as much as 31% from the present year’s high.
Emerging markets come with a lot of risk, but the huge rewards that they can potentially give you make them a good addition to your portfolio. The secret here is to take reasonable risks and to invest at the right time.