If you want to buy or sell investments, you’ll need to go on a financial market to trade them – it’s a bit like eBay, but instead of clothes or Pokémon cards, you get to trade different types of investments, such as shares, bonds, property, and commodities (things like oil, gold, and corn). Financial markets are quite varied, and they can be divided into subcategories. Typically, each investment type will have its own market – for instance, shares will be traded on the stock market.
But it doesn’t stop there, you’ll also find different markets depending on where you are in the world. Some markets will cover a particular place when other will include investments from different regions in the world – that’s the case of Emerging Markets. Here’s what you need to know about them.
What do we mean by ‘Emerging Markets’?
Emerging Markets, also known as Emerging Economies, are commonly associated with what we call developing countries.
By definition, these nations are striving to advance their economy, and to do so, they’re often moving away from legacy economic models, which relied heavily on agriculture and the export of raw materials. Most Emerging Markets are industrialising rapidly and adopting a free market, just like the US, UK, and Europe. Among Emerging Economies, you’ll find an heterogenous mix of countries like Indonesia, Brazil, and Egypt.
What are the characteristics of Emerging Markets?
The nations making up the Emerging Markets are very different – after all, we’re talking about countries present on all continents! However, despite their obvious disparities, their economies do have some similarities.
Rapid growth
Emerging Markets typically grow faster than those in Developed Markets. Let’s look at their GDP (Gross Domestic Product) which calculates the value of the goods and services they sell – this number is very useful as it provides us with a snapshot of economic performance. Indonesia and India, for example, saw their economy grow by 5% in 2019 – for reference, in the same year, the average GDP across the globe was only 2.5%. More impressively, Rwanda’s economy went up by 9.4% and Cambodia’s by 7.1%1.
Unsurprisingly, with Covid-19 and the global recession, developing countries have seen an economic hit to growth. But compared to developed nations, like Europe, many Emerging Markets will still likely be ahead in the game, in terms of GDP growth.
High volatility
Emerging markets are highly volatile – by this, we mean that they can move up and down very rapidly and fluctuations can be quite important. This high volatility is due to three factors:
- Natural disasters which can have a huge impact on economies that rely on agriculture or natural resources exports,
- Domestic political instability often accompanied with military unease and social upheaval, and
- Price shocks that occur when the price of a product or commodity suddenly changes due to an increase or decline of the supply this can impact both employment and government revenues.
Investing in Emerging Markets means accepting a higher level of risk overall, as the value of your investments could swing a lot. But remember, risk also comes with opportunities and choosing to invest in Emerging Markets could also give your money more potential.
Currency risk
For many years, Emerging Markets have seen extreme volatility in their currencies, and even today, some currencies continue to fluctuate a lot and can often lose value against the US Dollar (e.g. when 1 Brazilian Real is only worth 0.18 US Dollars2, down from 0.25 US Dollars at the start of 20203). However, it is worth noting that many Emerging Markets have large commodity sectors, where revenues are typically priced in US dollars and costs remain in their domestic currencies, which means that this impact is not universal across countries.
Institutional and Governance concerns
Regulations in Emerging Markets are typically less constrained than those in Developed Markets. This has the benefit of allowing companies to do business quickly, however it can also mean that management, rather than shareholders, have a greater say in the longer-term strategy of the company. A less developed corporate and government infrastructure may result in greater opportunities for firms able to provide a high-quality service, but it may also mean that support which might be expected to be present in Developed Markets is not there.
Political risk
Emerging Markets have classically seen greater political instability, resulting in more volatile elections, a less consistent rule of law, and failure to pay off debts, particularly those priced in foreign currencies. However, strong economic growth has also provided the incentive for longer term investments in education and infrastructure. This positive evolution has provided a more stable outlook for investors, but there are still continued flashpoints, which is why Emerging Markets can see great volatility around election time.
Liquidity risk
Liquidity, which relates to how easily and quickly your investments can be turned into cash, isn’t always guaranteed on Emerging Markets. During times of negative market stress there will usually be fewer buyers than sellers which will ultimately drive prices lower. In some Emerging Markets, prices may move faster and more than might be expected due to the imbalance between sellers and buyers. This means that investors will experience more volatile returns but could also expect higher gains.
Is it a good idea to invest in Emerging Markets?
Well, whether you invest in Emerging Markets will mainly depend on your risk appetite, financial situation, and investment goals. Emerging Markets are by nature less established and more volatile, hence riskier than Developed Markets – so, if you want to invest in Emerging Markets, make sure you understand and are comfortable with the risk you’re taking. But since they haven’t reached their full potential, they can also offer a greater scope for growth, so if you’re willing to do extensive research and thorough analysis, you could potentially benefit from higher-than-average returns.
However, if you’re too busy to do all the research and analysis on your own, you could use the help of investment experts. With robo-investing platforms, like Wealthify, the hard work is done for you. Our Investment Team will build you a diversified Plan with investments from different markets and they’ll make adjustments to your portfolio, when needed, to keep it on track with your risk level and goals.
References:
1: https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG
2: https://www.xe.com/currencyconverter/convert/
3: https://www.xe.com/currencycharts/?from=BRL&to=USD
Past performance is not a reliable indicator of future results.
The tax treatment depends on your individual circumstances and may be subject to change in the future.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
