The risks and rewards of emerging markets call for savvy investing. Our primer answers the most important questions
Emerging markets are all the same – or are they?Investment experts love grouping different emerging markets (EMs) into zippy acronyms such as BRIC (Brazil, Russia, India and China) – but the countries in them often have little in common, says Mark Dampier, Research Director at Hargreaves Lansdown Asset Management. “Each EM has its own characteristics: some are dependent on natural resources, while others produce cheap consumer goods made with low-priced labour. Some depend on an internal market, others on exports. Some rely on just one or two sectors and their stock markets have just a few shares that are difficult for foreign investors to buy and sell, while others have accessible and liquid stock markets. EMs may be prone to coups and civil unrest. On the other hand, some EMs have increasing levels of education, a growing tax base and middle classes keen to spend money on a higher standard of living.”
Are emerging markets more volatile?
10%
The percentage increase of volatility emerging markets face compared with developed markets
Source: Credit Suisse Global investment returns yearbook 2014Yes – but that volatility is decreasing. In the 80s and 90s, EMs experienced on average 15 or more crises per decade, compared with fewer than five for developed countries. The average EM was almost twice as volatile as the average developed market (DM) at the end of 80s. By the end of 2013, their volatility was only 10% greater.
Are emerging markets particularly sensitive to external shocks?
Yes. In the last 15 years, the 2001 US recession and Argentine debt default, the 2008 global credit crisis and the Fed’s 2013 announcement that quantitative easing would be tapered off have all caused big EM downturns. But it can work the other way around, too. The 1998 Russian default spilled over into other former Soviet republics, but also affected Brazil, Mexico and Hong Kong. It even hit the US through the collapse of the Long-Term Capital Portfolio hedge fund.
So, how have emerging markets been performing?
Unsurprisingly, the picture is up and down. In the first decade of the 21st century, they easily outperformed DMs. From 2000 to 2010, the annualised return on the MSCI Emerging Markets Index was 10.9% versus just 1.3% for developed markets. Since 2008 however, investors in EMs have experienced a true rollercoaster ride. During the 2008 credit crunch, the MSCI Emerging Markets Index fell by 53%, only to bounce back by 79% in 2009. And since the start of 2016, that same index has fallen by 24.7% at the time of writing.
What does the future hold for emerging markets?
With US interest rates on their way up, EMs now have to service increasingly expensive debts. The slowdown in China and knock-on impact on demand for commodities is also expected to cause ongoing problems. “That said, EMs are certainly cheap on most metrics and arguably so much negativity is priced in”, says Jason Hollands, Managing Director of financial planning firm Tilney Bestinvest. “We don’t rule out the prospect of these markets bottoming out during 2016: I’m just not sure we are there yet.”
Mark Mobius, who ran the Templeton Emerging Markets investment trust for 26 years, says that he is “not terribly concerned” about growth in China or its long-term investment prospects.
“We would dub current 2016 projections of about 6% in gross domestic product growth as quite strong, given that the size of the economy has grown tremendously.
“The fundamentals in China are still excellent. It is one of the fastest-growing economies in the world, even if the growth rate has decelerated.”
The original version of this article was published in the March 2016 print edition of the Review.