How to Invest in Emerging Markets

Emerging markets are small stock markets based in developing countries. In 1981 the International Finance Corporation of the World Bank defined emerging markets as any economy with a per capita annual gross national product of less than $9,385. More than 100 countries can be considered emerging markets as of 2009, and they encompass about 80 percent of the world’s population. The leading emerging markets are often referred to as BRIC—Brazil, Russia, India, and China.

For most investors an emerging market is a low-to-middle income country that is industrializing or otherwise growing, developing, and integrating into the global economy.

Emerging markets are generally considered high-risk investments. However, they also have the potential for huge growth and price gains. A small, long-term investment in emerging markets can help balance and diversify a more conservative portfolio.

Why Invest in Emerging Markets?

Most of the world’s resources and people are in the developing world. Countries that may one day become world leaders with dominant economies can be sound investments for the long term.
Developing countries often undergo periods of rapid growth. Some have economic growth rates that are two or three times those of developed countries. Companies that do business in these countries can have large earnings growth and stock price increases.
Some emerging markets include major corporations that have good management, innovative technologies, and global penetration.
The credit ratings of some emerging markets, especially those that have joined the European Union, have been improving.
Price-to-earnings ratios in emerging markets are often lower.

Why Are Emerging Markets Risky?

Emerging markets can experience frequent abrupt and wild fluctuations.
They have short operating histories.
They can be subject to nationalizations, changes in government policies, or expropriation of foreign money.
They generally lack credit markets for long-term business loans.
Their exports are dependent on the strength of the global economy.
Some are very dependent on imports and can be hit harder during global economic downturns.

Emerging markets can be volatile because of:

Economic and/or political or civil instability in the country or region
Currency fluctuations

Speculative panics
Market collapses

Advantages of Emerging Markets

Emerging markets can be cheaper than those already established.

During global economic downturns, some emerging markets may merely experience a cyclical slowing and may actually be in a stronger financial position.

Emerging markets may recover faster than others when the global economy begins to recover.
The increased flow of capital and consumer goods between emerging-market countries, such as China and Argentina or India and Korea, provides new sources of economic growth and may help them weather economic downturns.

Disadvantages of Emerging Markets

In addition to volatility and risk, emerging markets may have:

Higher transaction fees
Less available information
Stockowner restrictions
Restricted repatriation of local currency in U.S. dollars
Generally lower earnings

Before Investing

Know which countries are emerging markets.
Determine what you already own. Most foreign funds have some emerging-market holdings. A diversified international mutual fund may also have exposure to emerging markets.
Know your tolerance for market fluctuations, since emerging markets can be extremely volatile.
Know your tolerance for risk.
Diversify your holdings. Investing in only one country or region could lead to intolerable losses if that market implodes.
Invest for the long term because of volatility and the time required for full development of the emerging market.

Ways to Invest in Emerging Markets

Emerging-market investments can be in stocks, bonds, or mutual funds:

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Some broad-based, passive emerging-market index funds track various market indices.
Some emerging-market funds are heavily managed, shifting frequently among countries and regions, depending on factors such as commodity prices or movements of foreign investments. Some markets, like Russia and Brazil, are commodity dependent. Others, such as China and Korea, benefit from low commodity prices.
Some funds invest in European and American companies that benefit from growth in emerging markets.
Emerging-market exchange-traded funds (ETFs) have stock portfolios that are keyed to an emerging-market index.
There are brokers who specialize in emerging-market investments.

There are a large number of index and other funds for individual countries. You may want to wait and invest when a market is way down. If you feel confident investing in a specific country or region:

Be prepared for downturns.
Choose a region that has not already been heavily bought up.
Choose regions that are performing better economically than other parts of the developing world.
Choose countries where incomes are growing and are likely to continue to grow and grow faster.
Choose countries with a growing middle class and economies that are shifting toward consumer-driven growth.

Additional Resources