Exploring the Emerging Markets
By Matt Koppenheffer for Smart401k
When terms are thrown around as often and as liberally as “emerging markets,” it can sometimes be pretty easy to take the idea for granted and never step back and say, “What exactly does that mean?” So what are we talking about when we say emerging markets?
One way to start might be to look at the antithesis of an emerging market — what we might call an “emerged market.” An obvious example of such a market is the US, where we have a mature, industrialized economy, robust capital markets, and highly developed regulatory bodies. We could also take that mold and apply it to a bunch of other economies globally such as the UK, Japan, Canada, Australia, and the Netherlands — to name a few.
Now on the flip side, we could also look at the countries that are known as LDCs, or less developed countries. These are the countries that still have a lot of work to do before they become major players in the global economy. Often, political conflict or civil war has prevented these countries from making a real push towards industrialization. This group includes countries like Sudan, Cambodia, the Democratic Republic of the Congo, Afghanistan, and Haiti.
So where does this leave us? You may have noticed that some of the most exciting, high growth economies have not been mentioned yet — countries like China, India, Brazil, and Russia. Well guess what? These are actually part of the group that are defined as emerging market countries. This group of countries is well into the process of industrializing and creating robust and dynamic marketplaces for both goods and capital.
But we have to be careful not to pigeonhole the four countries mentioned above as the only emerging market countries. Those four have become the most well known of the emerging markets countries partly because of their size and fast growth, but also thanks to the handy mnemonic “BRIC” (Brazil, Russia, India, China) that was introduced by a 2003 research report from investment bank Goldman Sachs. However, the category also includes a variety of really exciting, though sometimes overlooked, countries such as Israel, the Philippines, Mexico, South Africa, Saudi Arabia, Turkey, South Korea, and Indonesia.
Now that we have a better sense of what we mean by emerging markets, the next logical question might be why we’d want to invest in them. In the enduring words of Bill Clinton: “it’s the economy stupid!” Or rather the growth in the collective economies of these countries. It’s hard to read anything in the realm of international business without hearing about the astounding growth in countries like India and China. And for investors, great economic growth typically goes hand in hand with bullish stock markets.
So the bottom line is that having some exposure in your portfolio to these high-growth countries can be like throwing some espresso in with your coffee — it can give your portfolio a little extra boost.
Well then, if that’s the case, we might logically wonder why it wouldn’t be best to just abandon the slow, plodding growth of the US and Western Europe for the excitement and high returns of the emerging economies. To carry forward the coffee metaphor a bit further, imagine if you abandoned your regular morning cup of coffee for an entire mug full of espresso. There might be some undesired consequences from such a move.
Though the emerging markets are quite attractive from an investor’s perspective when it comes to potential returns, they also carry quite a bit more risk than their already-emerged counterparts. In other words, these are economies that are still very wet behind the ears. It may be easy to forget when considering the size of China and its growing international clout, but the regulations and the governance in that country do not have a particularly long track record and there’s no guarantee that it will continue to keep the economy as open as it is or endorse the kind of pro-shareholder policies that, say, Americans are used to. Of course, China is only one example — the political and economic climate in China may even seem tame when compared to other emerging economies such as Russia, Colombia, the Philippines, Pakistan, and Jordan.
Just a decade ago, a financial crisis in Southeast Asia showed exactly why it pays to have selected exposure to these economies. A bubble in asset values in Southeast Asia led some countries — particularly Thailand — to prop up their currencies. When it became clear that this wasn’t going to be a long term solution and the countries began floating the currencies again, the bottom fell out and the region was plunged into economic crisis.
That type of outcome is a relatively unlikely one when it comes to investing in emerging markets. However, the fact that the risk is a real one is the reason that, while having some exposure to emerging markets is a good idea, it should augment a portfolio that’s grounded in stable holdings in developed markets.
You might say that your emerging markets holdings should be the delicious slice of cheesecake after dinner, but never your steak entre.
