What is an emerging market? How do we classify a country that is not yet fully developed but that can? Most importantly, how can we invest in this market with minimal risk? Emerging markets often offer a bonus diversification for our portfolio. Furthermore, their growth has the potential to outpace developed countries. Let’s take a trip around the world.
Table of Contents
What Is an Emerging Market?
Emerging markets slowly begin to trade and engage with other countries on a much smaller scale. What are the main differences between a developed and an emerging market? Certain characteristics define a developed economy. Emerging economies will fulfill some of the following conditions.
Emerging markets slowly begin to trade and engage with other countries but at a much smaller scale. What are the main differences between a developed and an emerging market? Certain characteristics define a developed economy. Emerging economies will fulfill some of the following conditions.
Market Volatility
Major economies have a stable economy. Their currency isn’t as volatile as others during major internal events.
We can easily compare the volatility of the Russian Ruble or the Turkish Lira to the US Dollar or the Euro.
Other points of reference can be interest rates and inflation. Developed countries have an interest rate of around 0-0.25%.
Emerging markets will have theirs much higher. Most developed countries try to keep an inflation rate around 2%. They try to keep the economy’s growth above the pace of the rising prices.
One of the current effects of the pandemic is much higher than the anticipated inflation rate. Hence, current statistics don’t reflect reality.
Emerging Markets Growth
Developed economies will grow at a stable rate of around 3%. However, emerging markets will grow much faster. Typically, it is between 6-7%, but it can go much higher. Governments will apply policies that favor growth and rapid industrialization.
Foreign Investment and International Trade
Emerging markets are a good option for investors seeking a higher risk/reward. Emerging countries receive foreign investment as they transition from agricultural to industrial economies.
This help will boost their competitive advantage, and some sectors will outgrow and outperform those of developed countries. This leads to more exports and trade with other countries as they slowly open up to more markets. Domestic financial institutions modernize, and regulations increase.
Emerging Markets GDP Per Capita
I am not a big fan of the GDP metric to measure the growth of a country. It doesn’t consider the disparity between the rich and the poor. The GDP per capita measure isn’t perfect, but the middle class is better represented with this metric.
Economies highly dependent on agriculture will have a lower GDP per capita. Drought years will affect their economic output. An economy focused on industrial activities will have a more consistent output with increasing results.
As the GDP per capita increases, the standard of living increases, and more citizens are out of the poverty zone.
Political Instability
Emerging markets will often have strong leaders. Instability and corruption are still present in the country to a higher degree than in developed countries but to a lesser extent than in many poorer countries. We can all agree that Putin, Bolsonaro, or Xi Jinping aren’t politicians we would like at the head of the US, Canada, or any developed European country.
All the metrics above are related, and one leads to the next. Emerging countries succeed in most but don’t excel enough to be considered developed. The following section will give a few examples of emerging countries.
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Examples of Emerging Markets
Although there are many emerging markets and economies around the globe, the focus here will be on five major ones. They are often given the acronym ‘’BRICS’, which was founded in 2006′.
Brazil, Russia, India, China, and South Africa constitute over 40% of the world’s population and more than 25% of its GDP. The leaders of all these countries meet annually and have strong economic ties.
1. Brazil
When the term BRICS was first coined, Brazil’s economy was growing according to the definition of emerging markets. Brazil has a strong tourism, oil, and agricultural industry.
However, political uncertainties tied to sanctions have slowed its growth. There has been lower economic activity and questionable decisions by the current leader, Jair Bolsonaro. The pandemic didn’t help Brazil.
The future still looks bright if the government can use its resources efficiently. A government turnaround might also be necessary to boost its international credibility.
2. Russia
Russia’s story has been unique. After the fall of the communist regime and the rise of Putin, Russia’s economy began to rise from the ashes.
Furthermore, the rise in oil prices helped to boost the economy. Various exports and friendlier terms with the West contributed to steady growth until 2008.
Over the last decade, Putin hasn’t been on good terms with the rest of the world—tensions with Georgia, Ukraine, Europe, and the US led to sanctions.
The declining oil price didn’t help an economy where 52% of exports are oil-related. Recently, due to the war with Ukraine, the fall of the Ruble and major stocks in Russia have further weakened the economy.
It seems that Putin’s reign is more beneficial to the oligarchs and himself than to the working class. Will Russia be able to rise once again from the ashes under Putin? His term will (maybe) end in 2036, and his actions can be very unpredictable.
However, the Russian economy can strongly rebound if Putin has a sudden change of heart.
3. India
India’s story is much more positive. The country is experiencing growth in various sectors. The economy is also growing steadily in the right direction.
Many multinational companies are emerging as leaders around the world. Some instability has been recorded due to Modi’s policies, but nothing too major.
India is currently one of the fastest-growing economies in the world. They are expected to be in the top 3 over the next 10-15 years.
Investing in their sector today can be a very good decision for the future. So keep watching this country with emerging markets.
4. China
There has been so much talk about China in the last decades. At one point, it seemed like everything was made in China. They are on their way to becoming an economic superpower and potential world leader. A few decades ago, many Chinese citizens lived below the poverty line. Now, less than 3% do.
China has also emerged as a technological hub. Many new companies like Huawei, Alibaba, and Tencent conduct their business worldwide. What is keeping China from being a developed country?
First, many companies are state-owned. Second, Xi Jinping isn’t exactly the proponent of democracy and equality among all; the Uighurs have made the news many times during his term. Many scandals involve the freedom given to Chinese citizens.
The pandemic hit China harder than other countries. However, they are well-equipped to rebound and dominate. Time will tell.
5. South Africa
The latest member of BRICS joined in 2010. South Africa’s economy is highly dependent on commodities. Hence, the price affects their export numbers. GDP numbers have been increasing, but so has the unemployment rate.
The country still faces major issues. They have to fix their criminality rate, government incompetence, high unemployment rate, and major policy reforms.
I believe the only two countries worth looking at in the BRICS category are India and China. They are the only two with steady GDP per capita growth and major international exposure.
Goldman Sachs created a BRICS fund to cover these countries. They were expecting their growth to surpass that of the G7. A few years later, GS realized how wrong they were.
The fund peaked in 2010 and has dropped over 80% since. 2015, the fund was closed after a 21% loss since inception. The decline of oil, paired with a global crisis, could be to blame. Russia, Brazil, and South Africa haven’t been stable economies since 2008.
6. Next Eleven (N-11)
The term next eleven is coined for the up-and-coming economies that can become BRICS. They include Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, Turkey, South Korea, and Vietnam. These countries were picked based on the conditions set earlier.
Mexico, Indonesia, Nigeria, and Turkey (MINT) are popular acronyms.
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How to Invest in Emerging Markets ETFs
Emerging markets are classified differently by different companies. The IMF and Standard & Poor’s include 23 countries, Morgan Stanley Capital International (MSCI) includes 24, Dow Jones includes 22, and Russell only 19. There exist some disparities among them. Some ETFs have been created for investors.
BlackRock owns the largest emerging markets ETF available with an expense ratio of only 0.11%. The top holdings include Taiwan Semiconductor, Tencent, Alibaba, and Samsung. Tech and the financial sector represent more than 40% of the holdings.
Companies in China, Taiwan, India, and South Korea represent almost two-thirds of the holdings. The fund has much potential once the pandemic restrictions are lifted for good. These are highly dense countries with many COVID issues.
1-year return: -1.21%
3-year return: 21.74%
5-year return: 33.03%
Dividend yield: 2.97%
2. Vanguard Emerging Markets (NYSEARCA: VWO)
Vanguard also offers an interesting fund for those seeking diversification with emerging markets for a 0.22% expense ratio. The major difference between both funds is South Korea’s and Samsung’s omittance. Brazil took over as the 4th largest occupant. The tech and financial sector represent 45% of the fund.
1-year return: -0.51%
3-year return: 21.33%
5-year return: 30.48%
Dividend yield: 2.56%
Both funds above offer a diva. Investors can buy shares of companies that make the bulk of the ETFs or have a more diversified approach with one of the many available ETFs. Russia’s massive economy isn’t well-represented. Too many risks are present due to ongoing conflicts.
Final Thoughts: How to Invest in Emerging Markets
Many countries can be classified as emerging. Some have been upgraded to develop in the recent decade, while others were downgraded. In the upcoming years, many countries seem to be on the path to moving up and joining the ranks of the elite. If I had to pick two to have a strong run over the next few years, they would be China and India. Emerging markets provide additional diversification for a portfolio, but they can also cause extra headaches.
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