Emerging Markets: Invest or avoid?

Investing in Emerging Markets can be a bit like blue cheese – some love it, some won’t go near it, and others would like to try it but just can’t bring themselves to. Dairy analogies aside, let’s explore what you need to know about Emerging Markets and look at whether they’re any good as an investment.

What are Emerging Markets?

Emerging Markets are developing countries that are growing and heading towards ‘developed’ economy status. Classic examples of Emerging Market countries include the so-called BRICs of Brazil, Russia, India and China, but there are dozens more including Mexico, South Africa, UAE and Thailand. Beyond Emerging Markets you’ll find ‘Frontier Markets’, which are economies that are even smaller and less developed. Despite what some may think, Emerging Markets aren’t the wild-west in economic terms, but are on the road towards strong, stable economies.

From an investment point-of-view, Emerging Markets are a much smaller category than developed ones, making up a significantly lower percentage of the global stock market. They are no less diverse though, with hundreds of companies of all shapes and sizes and from all the various industries and sectors.

In some ways Emerging Markets are actually more diverse than developed ones. The largest Emerging Market – China – forms less than one-third of all Emerging stock markets. To put this into perspective, the USA makes up over two-thirds of global developed markets.

Should I invest in Emerging Markets?

As with anything, there are both pros and cons to investing in Emerging Markets. It’s generally higher-risk than investing in developed ones, as they tend to be more volatile. Their less-developed economies can be more vulnerable to global disruption, and they’ve usually fallen further during market turbulence.

Emerging Markets can also go through periods of weak performance, as they have recently. In 2021 they fell 2.5%, while the global developed stock market rose 21.8%. They’ve lagged over the longer term too. In the 10 years to 31 January 2022 Emerging Markets delivered a 50.3% return while developed markets left them in their dust with a 198.1% gain.

Now before you wonder why anyone would bother investing in Emerging Markets after those returns, there are times where the fortunes reverse and they’ve performed much better than the developed world. In the 10 years to 31 January 2012, for example, Emerging Markets gained 294.3% compared with a rather more paltry 54.5% return from developed markets.

Of course no-one knows what the years ahead hold in store for either Emerging Markets or developed ones, but there are some strong arguments for investing in the former alongside the latter. Performance aside, adding Emerging Markets to a portfolio increases the variety of countries and companies you invest in, which improves diversification.

Their outlook is compelling too. 85% of the world’s population live in Emerging Markets and they account for around 60% of global GDP. Yet they make up only 10-15% of the global stock market. Their growth forecasts are also higher than many developed market forecasts and Emerging Markets are already the biggest driver of global growth and wealth creation.

Our thoughts on Emerging Markets

We think Emerging Markets present a significant opportunity for long-term investors. That’s why we have them in most of our portfolios. Of course investing isn’t just about return potential – it’s also about managing risk. So given their tendency for more volatile returns, we moderate their exposure and invest more in Emerging Markets within our adventurous portfolios than in our more balanced ones, and not at all in our cautious portfolios.

Emerging Markets can present challenges from an environmental, social and governance (ESG) perspective. Companies from emerging economies generally have weaker ESG standards than those from developed countries. That’s why our preferred way to invest in Emerging Markets is using an ESG approach that filters out companies with poor ESG records and controversial industries.

Overall, we think Emerging Markets have bags of potential. For those that can tolerate their bigger ups and downs, investing in them alongside developed markets leads to better-diversified portfolios and could also boost your long-term returns.