Investment Opportunities In Emerging Markets

Investment is both a science and an art, which is why analysts can never accurately predict the risk and return of an asset class. Market researchers can predict trends, estimate associated risks, and guide on how to hedge the risk with minimal impact on returns. So, depending on risk profiles, investors must diversify their capital across multiple asset classes. 

In this article, we discuss investment opportunities in emerging markets (EMs), their characteristics as asset classes, advantages, and disadvantages. Stay with us. 

What Is an Asset Class? 

In theory, of financial investment, an asset class is a homogenous group of marketable assets with similar economic and financial characteristics and behaviour. 

For example, fixed income is an asset class. This class includes different assets, like government bonds, corporate debts, municipal bonds, and many more. Some of the prominent characteristics of fixed-income assets are: 

• Zero or near-zero risk 
• Low return 
• Slow appreciation in price 

Investment opportunities in emerging markets are also examples of a homogenous asset class for cross-border institutional and individual investors.  

Read More About Asset Allocation

What Is an Emerging Market?

The global economy has changed a lot since the ‘emerging market’ term was coined in the 1980s. However, the basic investment perception behind the term remained unchanged. 

An emerging market is an economy that has tremendous growth potential or is moving along a rapid growth trajectory. The potential economic growth can push the economy toward a higher income level. 

For example, a low-income country, which is on the verge of becoming a lower-middle-income or middle-income economy, can be termed an emerging market. 

The standard characteristics of emerging markets are: 

1. Strong growth potential 
2. Industrialisation 
3. Increase in per capita income 
4. Volatility in the political environment and policy decisions 
5. Unstable currency 
6. Growth in the size of the middle class 

Strong growth potential 

The strong and sustainable growth potential of the economy is singularly the principal characteristic of any emerging market. It makes investment in emerging markets highly attractive despite the associated risks. 

Industrialisation 

Most emerging economies are agrarian economies experiencing major industrialisation or shifting from traditional production systems to modern capital-intensive industries.   

Increase in per capita income 

To make any growth sustainable, an increase in per capita income or a growth in people’s earnings is important. It helps to fuel growth further by creating domestic demand. So, emerging markets must experience an actual growth in per capita income. GDP growth may not be sufficient, especially in economies with high income inequalities.  

Volatility in the political environment and policy decisions 

One of the major reasons behind less than potential economic growth in emerging markets is volatility in the domestic policy framework and political instability. It makes emerging markets assets risky. 

Unstable currency 

High volatility in currency exchange rates or lack of liquidity in currency markets is another characteristic of emerging markets. These economies may often have restrictions on the movement of capital. It makes returns from investments in such an asset class more open to volatility. 

Growth in the size of the middle class 

A growing middle class is the sign of mass economic prosperity, an increase in the educated labour force, growing consumption, and the creation of wealth. So, every successful emerging market witnesses a growing middle-class population. 

Depending on these characteristics, emerging markets at present across continents are: 

Why Should You Invest in Emerging Markets?

Global investors look for investment opportunities in emerging markets for two major reasons: 

• Higher returns 
• Asset diversification 

Higher returns – Asset classes in emerging markets offer high returns compared to their counterparts in developed and matured economies. The primary reason behind the high return is the strong growth potential of these economies. Besides, low liquidity in emerging capital markets also causes an undervaluation of assets. 

Asset diversification – Asset diversification is a strategy to manage investment risks and ensure long-term value generation in a portfolio of investments. Putting the entire fund in only one or two types of asset classes can make a portfolio susceptible to risks during market volatility. So, depending on the risk appetite, investors often distribute their capital across multiple asset classes with different risk profiles. Emerging markets offer high returns with higher risk. It can serve the purpose of risk assets in a portfolio.   

RoI Profile From Emerging Markets

MSCI or Morgan Stanley Capital International Emerging Markets Index, is a globally recognised investable market index (IMI) for representation, benchmarking, and tracking the performance of investment opportunities in emerging markets. 

Over the last 3 decades, the MSCI Emerging Markets IMI:

• Delivered 4.83% CAGR or compound annual growth rate 
• Sharpe ratio is 0.27 
• The standard deviation is 20.34% 

Average Returns of MSCI Emerging Markets IMI: 

Risks of Investing in Emerging Markets 

The major risks to investment in emerging markets are: 

• Political risk 
• Currency risk 
• Economic risk  

Political risk – Political instability is one of the major characteristics of emerging markets, along with the lack of a strong judiciary and absence of absolute sovereignty. These may cause a lack of long-term policy commitments. It increases risks for investors. 

Currency risks – Emerging market currencies can be highly volatile compared to the US dollar. It increases the cost of investing in these markets and might destroy gains from investments.

Economic risks – These markets may have the potential for rapid economic growth but it depends on supportive business environments, availability of resources and pro-market regulations. Disruption of these factors may compromise actual economic growth in emerging markets. 

How to Invest in Emerging Markets?  

Financial institutions and super high-net-worth individual investors can directly make portfolio investments in emerging markets. However, for retail investors options are limited. Some of the standard routes of investment in emerging markets are: 

• Mutual funds 
• Exchange-traded funds 
• Private portfolio management services 
• Privately managed funds    

Conclusion 

Investment opportunities in emerging markets can vary from fixed-income assets and real estate to equity market assets. Depending on the investment corpus and risk appetite, you can also decide to invest directly in emerging markets startups. However, it is essential to remember any investment outside the legal jurisdiction of your country can be risky. Understand the risk and return payoff of your investment portfolio. Consult with financial planning and investment experts. 

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