If you’re considering diversifying your portfolio outside of the UK, you may be wondering how to do it.
Emerging markets, which are countries progressing towards becoming ‘developed’ countries, can offer diversification, but there’s much to consider.
We look at what emerging markets are, why you should consider investing and the pros and cons.
Summary
- Emerging markets are countries that are in the process of growing from developing to developed.
- The returns from investing in emerging markets can be high, but it can be risky due to volatility.
- Unbiased can help you find a financial adviser to support your investment strategy and long-term goals.
What are emerging markets?
The term ‘emerging market’ was first used by Antoine van Agtmael in 1981.
Emerging markets are economies that are progressing toward a developed country, which is typically defined by developing financial markets, a regulatory body and a stock exchange.
An emerging market has the potential for strong economic growth. It is more established than a frontier market, which is usually deemed too small or risky but less than a developed one.
They can be attractive to investors due to their rapid growth prospects, but they can be volatile and, therefore, risky.
An ideal emerging market benefits from consistent growth but does not struggle with political or social unrest. This can be tricky to predict.
Why should you consider investing in emerging markets?
As mentioned, emerging markets can benefit from rapid growth and potentially high returns, which can beat their developed counterparts.
Emerging markets also tend to benefit from high population growth and technology developments while having decent valuations, so you’re not paying too much for your investment.
According to investment manager Baillie Gifford, many emerging market countries experience positive macroeconomics and have strong companies with low valuations and fast growth.
Finally, emerging markets offer diversification as you won’t solely be exposed to one country or region, so you reduce the overall risk of your portfolio.
What are the best emerging markets to invest in?
Brazil, Russia, India, China and South Africa, also known as BRICS, are popular, as their collective gross domestic product (GDP) recently surpassed the G7’s, the world’s seven largest ‘advanced’ economies.
The G7, also known as the Group of Seven, consists of Canada, France, Germany, Italy, Japan, the UK and the US.
According to IG, the following are the top emerging markets in terms of GDP:
- China: $15.5 trillion
- India: $3.2 trillion
- Brazil: $2.3 trillion
- Russia: $1.8 trillion
- Mexico: $1.3 trillion
- Indonesia: $1.2 trillion
- Turkey: $961 billion
However, the MSCI World Index, covering mid and large-cap companies across 23 developed countries, has delivered five times the return of the MSCI Emerging Market Index since June 2010.
The latter index includes mid and large-cap companies across 24 emerging market countries.
Bailee Gifford flags that despite this period of underperformance, emerging markets have outperformed developed ones since 1987.
With emerging markets, it’s a good idea to consider a fund or exchange-traded fund (ETF) to gain broad exposure rather than picking one or two developing economies.
It’s always wise to talk to a regulated financial adviser before investing to develop an investment strategy and ensure a diversified portfolio.
How to invest in emerging markets
If you’re interested in investing in emerging markets, investment platforms can be an easy way to invest.
ETFs
You can invest via an ETF, which can track companies from many different countries, although many favour China as it has the highest GDP out of the emerging market countries.
Alternatively, you could look into an ETF that covers a specific country or a sector, although if you go down this route, you should consider multiple ETFs so you have some diversification.
Some ETFs may be less risky than others by tracking stable and more resilient companies in emerging market countries.
Emerging market index funds
You could also consider emerging market index funds, which are similar to ETFs but are priced at the end of each trading day.
In contrast, ETFs can be bought and sold like common stock several times.
Stock market
Finally, you could invest directly in companies listed in stock markets in emerging markets or those in the UK that operate in these markets.
However, this last option can be tricky. You’ll need to do your research, and you could end up with an undiversified portfolio. If your single investment drops in value, other investments won’t offset these losses.
A financial adviser can be useful in making sure your investment strategy works for you, although it does cost to get advice.
With any of the above options, you should ensure that any fees are reasonable and don’t eat away at your long-term returns.
What are the pros and cons of investing in emerging markets?
There are many advantages and disadvantages you must consider before investing in emerging markets.
The pros of investing in emerging markets
- Potential for high returns: The average returns for emerging markets can vary. Global asset management firm Alliance Bernstein says the MSCI EM index delivered annualised returns of 15.9% between 2001 and 2010.
- Emerging markets exposure helps to diversify your portfolio: If your investment strategy is limited to certain countries or sectors, emerging markets can be a good way to achieve diversification.
- You don’t necessarily need to invest in emerging market countries to benefit: If you’re concerned about the risks of emerging markets, you could invest in UK or US companies that have global operations, including in developing countries.
The cons of investing in emerging markets
- The volatility of emerging markets can make returns unpredictable: Investors may struggle with unpredictable returns. For example, Alliance Bernstein flagged returns of 15.9% between 2001 and 2010 via the MSCI EM index, yet only 0.9% annualised returns since 2011.
- You risk investing in an emerging market too late: With emerging markets, you want to invest before the country surges in growth to benefit from the best rate of return and to reduce costs. Also, due to the volatility of emerging markets, it’s best to have a long-term view.
- Any setbacks with emerging markets can be costly: It’s hard to predict what will happen with any investment, but emerging markets can be particularly tricky. A country can experience setbacks that slow its progress towards a developed country from various factors, such as political and social unrest and natural disasters.
Are emerging markets a good investment?
Emerging markets can be a good investment if you’re happy with a higher level of risk and accept that there will be volatility, especially considering the performance of the MSCI EM index.
While there have historically been strong returns over some time periods, there have also been disappointing returns at other points.
As emerging markets can be a risky investment, it’s highly recommended that you get financial advice to make sure it is right for you and that you can fully understand the risks and rewards.
What’s the outlook for emerging markets?
While sentiment towards emerging markets has been struggling, there are some reasons to be optimistic.
For example, Lazard Asset Management believes emerging markets are more attractive as they are among the ‘most mispriced asset classes globally.’
The asset management firm says earnings growth is expected to be higher this year compared to developed countries due to emerging Asia and information technology companies.
However, the risks are possible slow growth in emerging markets and inflation rising again.
J.P. Morgan believes the outlook for emerging markets will be influenced by US growth and falling inflation, while growth in developing countries is forecast to decline slightly.
Considering investing in emerging markets?
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