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What is an Emerging Market?

In 1988 there were just 10 emerging markets – representing 1% of the total value of shares available to private investors. Today there are 24

Emma Wall 10 July, 2017 | 11:00AM

This article is part of the Morningstar's Guide to Emerging Market Investing. Click here to find out just what an emerging market is and which regions hold the potential to boost your investment portfolio.

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 15% of the investable market. In the decade from 2003, emerging markets went from making up 24% of worldwide GDP to 43%.

Those investors who were savvy enough to invest in emerging markets during that time have been rewarded – the First State Global Emerging Markets fund has returned on average 9.6% every year for the past 10 years, while Aberdeen Emerging Markets has returned 9.5% annually and Baillie Gifford Emerging Markets Growth managed 7.1% 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 takes an approach that 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.

Most recently, MSCI has announced plans to include China A shares – that is those listed on the mainland, rather than Hong Kong – into its emerging market indices, which will further weight the China allocation in a passive fund tracking this index.

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 in part reliant on exports and commodities: 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.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Aberdeen Emerging Markets Equity A Acc730.86 GBP-0.29
Baillie Gifford Emerging Mkts Gr A Acc669.11 GBP-0.42
Stewart Investors Glbl EmMkts A Acc GBP790.53 GBP-0.44
About Author Emma Wall

Emma Wall  is Senior Editor for Morningstar.co.uk