By Pablo Pazos
Like any other investment opportunity, there are great benefits and potential risks to investing in emerging markets. It is important to understand what emerging markets are and the associated benefits and risks that an investor must consider.
Emerging market economies are often referred as those countries whose economies are experiencing rapid growth and are progressing into an advanced economy. According to Investopedia, common characteristics of emerging markets include having a “market exchange, a regulatory body, and liquidity in local debt and equity markets” as well as an established financial infrastructure that includes banks, a stock exchange, and a unified currency. There is no definitive consensus on which countries are deemed emerging markets, but the International Monetary Fund (IMF), Morgan Stanley Capital International (MSCI), the Standard and Poor’s and Russell indexes, and the Dow Jones have provided a current list of countries and which each institution classifies as an emerging market economy. Countries that appear on each one of those lists include: Brazil, Chile, China, Colombia, Hungary, Indonesia, India, Malaysia, Mexico, Peru, Philippines, Poland, Russia, South Africa, Thailand, and Turkey.
With expected growth of two or three times faster than developed nations, emerging markets can outperform returns from securities in developed markets. Furthermore, an investor can diversify his or her portfolio by investing in emerging markets that may not be affected by economic slumps of mature economies, thus allowing the investor to attain some returns on a portfolio that may experience loss in value from its domestic securities. For example, after the United States housing crash and resulting credit crisis, it was emerging markets like Brazil, India, and China that saved the world market.
However, investors should consider the significant risks that come with investing in emerging markets. First, returns from securities in emerging market economies may lose value when investors acquire their returns in weak local currencies that need to be converted into dollars. Additionally, some countries may lack the ability to pay back their debts and the political climate can be unfriendly to foreign investments. Government seizures of private companies or regulatory authorities that prove to be ineffective in preventing corruption or insider trading may result in the loss of foreign investment and value of emerging markets securities. For example, JBS, the world’s largest meatpacking company (based in Brazil), suffered a 30% decrease in valuation in Brazil’s stock market after revelations of potential insider trading and bribery from JBS executives with government officials.
There is an ever-increasing growth of investment opportunities outside developed markets that investors should contemplate when seeking growth in their portfolio, but this should be done with the consideration of the risks that may affect the value of such investments.