This article is part of Your Guide to Emerging Markets. All this week, we are focusing on emerging markets, sharing their potential pitfalls – and where you can make a pretty penny.
There are currently 24 emerging markets as identified by indexer MSCI: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Russia, Qatar, South Africa, Taiwan, Thailand, Turkey and the United Arab Emirates.
Twenty-nine years ago, there were just 10 countries in this sector – representing just 1% of the total value of shares available to private investors. Today those 24 nations represent nearly 30% of the investable market. In 2003 emerging markets made up 24% of global, GDP. According the International Monetary Fund they make up 59.75% today.
Those investors who were savvy enough to invest in emerging markets during the 90s have been rewarded – emerging market funds have tripled initial investments. Even in the 10 years since the global economic crisis, the Steward Investors Global Emerging Markets fund has returned on average 9.2% every year for the past 10 years, while Aberdeen Emerging Markets has returned 7.4% annually and Baillie Gifford Emerging Markets Growth managed 6.7% a year.
Unfortunately for those trying to get their head around emerging markets, there's no universally embraced definition of what constitutes an emerging, or developing, market.
Classification systems vary widely between indexers and benchmarks. Morningstar data relies on the World Bank's methodology for classifying markets as developed or developing. To arrive at a country's classification, World Bank focuses on a country's economy and, in particular, its relative level of wealth per capita. Countries with high levels of per capita income are classified as developed.
Meanwhile those countries with low, middle, and upper-middle incomes per capita, relative to incomes in other countries around the globe, are classed as developing, or emerging. Countries with even lower levels of income per capita are deemed frontier markets. These tend to have more volatile, less diverse stock markets and the companies have poorer levels of corporate governance.
Indexer MSCI examines each country’s economic development, size, liquidity and market accessibility in order to be classified in a given investment universe. If a country is awarded “emerging market” status it means that both active and passive funds which use the MSCI Emerging Markets index as a benchmark can invest in companies listed in that country – resulting in significant foreign investment.
In June 2013, MSCI announced plans to upgrade both Qatar and the UAE to emerging market status. At the time HSBC estimated inclusion in MSCI’s Emerging Market Index could attract $800 million of new inflows into the two countries’ markets as more risk-averse investors start to consider them. Similarly when MSCI downgraded Greece from developed market status to emerging market status later that year it triggered a slew of trades.
Just last month, MSCI added China A shares – that is those listed on the mainland, rather than Hong Kong – into its emerging market indices, which passive funds tracking this index re-balanced their portfolios to include A shares too. Inclusion in a globally recognised, and tracked, index has a duel impact; the shares themselves rise in value with demand, and investors benefit from greater portfolio diversification and more investment opportunities.
That is not to say emerging markets investing is risk-free or a one way ticket. Because of the nature of these countries’ development emerging economies’ stock markets are liable to volatile. Macro events such as the global recession hit emerging markets hard – with some regions still not fully recovered.
On the whole their economies and stock markets have less diverse revenue streams and tend to be more reliant on exports and commodity prices, both of which are controlled by external factors. However, many emerging economies – including China – are refocusing themselves to be domestically driven, much like the current UK economy.
