Emerging Markets
As you become more familiar with different sectors of the market to invest in, you will come across the Emerging Market sector.
When I studied Economics in college emerging markets were known as “underdeveloped countries” then “developing countries” and now “emerging” and “frontier.”
I wonder if any of the emerging countries I studied emerged into a developed country.
I had an economics professor who used to quip “Brazil is a country of the future and always will be.”
Not to pick on Brazil but it has been in emerging status for decades.
Is there a time limit on how long a country can be emerging? As some point shouldn’t they “emerge”?
And if they don’t graduate from emerging to developed, what does that mean? Does it matter?
Is China an emerging market?
These are the questions that keep me up at night.
Emerging markets have some common characteristics. However, it is not a neat and tidy classification
In general:
Low per capita GDP.
Not a great measure. The size of the population can make the numbers larger or smaller.
Higher Growth Rate.
This makes sense because economic growth is related to production. The more a country can produce and export the higher the growth rate.
Developing regulatory bodies and exchanges.
We may think the US is overregulated. In emerging markets there may be little to no regulation. This is what makes investing in some countries risky.
What happens if you buy stocks or bonds in a country that decides to put capital controls in place after you have invested.? You may not be able to liquidate your stocks or bonds. This is a liquidity issue.
Frequent political or economic instability.
Without “the rule of law” [1] or highly developed financial markets, countries that are developing, risk sudden regime changes.
Some emerging countries have no capital markets so you cannot invest in them through the financial markets.
Currencies can be volatile.
Anytime you invest in a non-US Dollar country you have currency risk. That is a given. In emerging markets exchange rates can be volatile due to lax monetary policies or inexperience in the global markets.
I’m going to throw in another characteristic. You won’t find it on the World Bank of IMF websites because it is hard to measure, and no one really wants to acknowledge it.
Corruption.
There is a non-governmental institution whose purpose is to combat global corruption.
The name of the company is Transparency International, and they publish a corruption index by country.
You can view the rankings of 180 countries on their website.
https://www.transparency.org/cpi2018
To give you an idea of how the corruption index works it is scaled from 100 to 1. A score of 100 would mean there is no corruption.
There is no country in the world that has a score of 100.
Denmark is in the number one spot with a score of 88 followed by New Zealand and Finland.
The US is #22 with a score of 71. Not even in the top ten? Looks like we have some work to do.
- Argentina is #85 on the list with a score of 40.
- China is # 87 with a score of 39.
- Mexico is # 138 with a score of 28.
- Somalia is last on the list with a score of 10.
All four countries I have listed above are “emerging market” countries.
If you are investing in emerging markets, there are significant differences in many of the countries. You can’t compare China to Somalia.
Although China is 87th on the list, I would not categorize China as an emerging market.
How could the US be in a trade war with the second largest economy in the world?
The perception is that emerging markets are risky. In some countries that perception is more true than other countries. But as countries work to improve the lives of their citizens the lines between developed and emerging are becoming murky.
Buying the sovereign debt of an emerging market nation may be less risky than buying US high yield (junk) bonds.
The reason investors buy emerging market debt and equity is the potential for higher returns.
The higher the expected return the higher the risk.
Should you invest in emerging markets ?
First: I would say that using a mutual fund or ETF would be the way to go.
Second: Check out the countries in the fund . You can’t change what a fund owns but if there is a large weighting to a specific country you are not comfortable with then look for another fund.
Third: As always check the fees. Fees in emerging market funds tend to be higher than plain vanilla funds.
Last: As always, keep your allocation low on a percentage basis. Start with 1-2% of your assets. Higher returns mean higher risk, which in turn means higher volatility .
[1} Rule of Law
The rule of law is defined in the Oxford English Dictionary as: “The authority and influence of law in society, especially when viewed as a constraint on individual and institutional behavior; (hence) the principle whereby all members of a society (including those in government) are considered equally subject to publicly disclosed legal codes and processes.”[2] The phrase “the rule of law” refers to a political situation, not to any specific legal rule.
https://en.wikipedia.org/wiki/Rule_of_law
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