Investing in Emerging Markets – What to Know Before You Dive In
If investors were to gain more insight into the inherent risks and rewards that are often associated with investing in emerging markets, they would then be in a much better position to answer the question of which allocation was most in line with their investment goals.
Investing in most emerging economies happens via mutual funds or exchange-traded funds (ETFs), so a couple of experts from Quilter Cheviot’s Carly Moorhouse and FundCalibre’s Juliet Schooling Latter give us some investor tips first.
Political Instability
By investing in emerging markets, investors can diversify their portfolio but while some emerging markets have very high potential, others have local conflicts, severe economic issues and other bad news. Some countries, in particular, are seeking to balance spending requirements with the need to promote economic development – a path that risks burdensome levels of debt, especially external debt. This potential impact on investment returns is one that investors should inevitably consider. Others suffer from exchange rate volatility relative to the dollar, which can hamper returns on investment. A strong dollar might make it tougher for a developing country to import raw materials from around the world and ultimately pay its foreign suppliers. Remember any country could one day suffer an economic disaster that affects their economy and stock prices, as well as the stocks of other countries around the world. Your Ameriprise financial adviser can help keep tabs on world events and also develop a portfolio in keeping with your risk tolerance and objectives.
Currency Risk
If there are two things in this world you can be certain of, it is death and taxes – or, at least, that’s what the saying goes. For businesses with foreign currency exposures, there is also a risk associated with the value of ‘local’ currency. A depreciation in the local currency of a selected emerging market may be expected to depress reported profits directly, but could also negatively affect the organisation’s cash flows. Disorderly depreciation toward fundamental economic levels could be positive, but sharp selloffs could destabilise capital markets and liquidity, threatening to create funding gaps at banks and leave investors with no good way out of emerging-market positions. Treasurers should apply an integrated approach in managing emerging-market currency risk when choosing individual countries or regional groups, sourcing professional advice, and developing long-term strategies. Treasurers can, thus, reap the benefits of growth without increasing the functional risks of their operations.
Regulatory Environment
Three main regulatory issues might prevent investors from putting money into emerging markets: weaker protection of property rights, weaker trade laws and higher costs of complying with local regulations. The global economy is a highly complex spaghetti of laws and regulations developing all over the world, in a continuous process. One can argue that the resulting enormously complex regulatory environment, both nationally and internationally, is one of the most difficult ones to grasp. Paul Samuelson’s Public Interest Theory of regulation is one such counter-argument. On this view, the market does not necessarily tend towards optimal results because it is full of monopolies and externalities, but governments can solve these problems through regulations aimed at promoting public health and welfare. Other theories argue that regulation is socially inefficient. Neo-liberal economists Ronald Coase and Douglass North argue that the high, increasing the overall costs of transactions; and Public choice theory argues that its economic benefits may be captured by its political beneficiaries.
Companies With High Growth Potential
Many investors favour emerging markets because of the potential of these countries to quickly become mature consumer societies. Their young demographics are keen to spend money on goods and services. Lower valuations too, as emerging market companies tend to be cheaper than their developed market counterparts, with earnings growth that is faster. An expanding EM investable universe, covering 24 countries and accounting for 49 per cent of global market capitalisation, also aids the bull case. ETFs and mutual funds will outperform individual EM stocks because they are more broadly diversified. Take the Dodge the increasing demand for equities is evident in the growing fund flows into funds I invest in. In the face of the Great Recession of 2007-09 and the Eurozone crisis of 2011-12, investors flocked to capital preserving debt and cash instruments. But today, there’s a strong demand for stocks; witness the new money into the funds with which I invest. Shifting exposure to higher-risk emerging markets can be beneficial, but it can also be risky. Understand portfolio by speaking with one of Ameriprise Financial’s advisors or making an appointment online.
