Investors that have had to make a choice between funds they will pay into will probably have come across the term ‘emerging markets’. Lots of funds have it in their title and even more somewhere in the details of what the fund invests in – especially global funds that include shares from companies from all over the world.
But what exactly does the term ‘emerging markets’ mean? Why are some funds focused on exactly emerging markets and why do more have some emerging market investments? What’s the value of the category to investors?
What Kind Of Shares Are In The ‘Emerging Markets’ Category?
Categories help order large numbers of ‘things’ into groups. Categorising ‘things’ is rarely completely objective or black and white. But the idea is all of the members grouped together under one category have some common quality that means they behave in a similar way under particular circumstances.
When we’re talking about shares, there’s a few ways they are categorised. One is by industry – so ‘tech’ companies, ‘energy’ companies or ‘consumer goods’ manufacturers. Another is by the stage a company is in. So ‘growth’ shares are those of companies still growing quickly – like the big tech companies. ‘Income’ shares are those of companies growing less quickly. Instead of investing most of their profits into expanding, they give them back to shareholders as dividends.
Shares are also often categorised by geography. You will see funds that include ‘UK’ or ‘USA’ or ‘Asia’ in their title. Quite often combined with another category, like ‘tech’ or ‘growth’. Which basically tells the investor the fund is made up of shares of companies that belong to that, or those, categories.
Finally, shares can also be categorised by how ‘developed’ the stock market they trade on, and the national economy it is based in, are considered to be.
Developed economies, or markets, are those that have established international stock markets with good liquidity, strong regulation, high overall value and are located in countries with relatively high average income per capita. The UK, Western Europe, North America, Japan, Australia etc. all count as ‘developed’ markets.
Emerging markets are countries that usually have lower average income levels and/or less mature stock markets but which are often growing and developing quickly. Countries like Brazil, India and China fall under the emerging markets category but so do many others from Taiwan to South Africa. It’s a broad group and one that isn’t always defined in the same way. Sometimes stock markets such as South Korea are categorised as ‘developed’ while others consider these same exchanges part of the ‘emerging markets’ category.
Investing In Emerging Markets – Pluses and Minuses
The attraction of an investment in companies in emerging markets is that historically they have shown the potential to, on average, grow more quickly than those in developed markets. That’s because they, again on average, earn a bigger part of their revenues from faster growing economies. MSCI, the index company, recently published figures that showed its Emerging Markets index, which tracks a selection of over a thousand companies across 24 emerging markets stock exchanges, returned an annualised 9.17% since December 29th 2000. Its World Index, that tracks companies across 23 developed markets stock exchanges, returned an average 5.2% over the same period.
The downside to an investment in emerging markets is that their economies are usually more volatile than those of developed markets. Historically, they have seen steeper and more regular ups and downs. Volatility also has a negative impact on long term investment returns and is why the returns that can be hoped for from emerging markets are considered higher risk.
A long term investment in emerging markets funds could help boost overall portfolio returns by tapping into faster growing economies. But volatility can be expected. Most long term investors limit emerging markets investment to a small part of their portfolio, and reduce it as the end of their investment horizon gets closer as they will have less time available to ride out any market drops.