Emerging markets are the markets of countries that are in the process of developing into industrialized economies. They typically share several common traits. Investors can buy into individual emerging market stocks, but sector newbies may prioritize exchange-traded funds or mutual funds, which offer built-in diversification.
After a decade of disappointing sector performance, emerging market stocks earned a brief bump in early Q4 2021. Still, emerging market stocks under the MSCI Emerging Markets Index landed on a 20-year low as compared to its main U.S. counterpart, the S&P 500.
Here’s what investors can look for in emerging marketsand the stocks that represent themover the next few years.
TL;DR
- Emerging markets or emerging economies refer to the economies of nations that are developing and growing rapidly.
- Some examples of emerging market countries are China, India, Russia, South Africa, and Brazil.
- Investors can diversify their holdings by investing in an emerging market fund, especially if economic growth is potentially strong in those markets.
- Emerging market stocks have the capacity to offer high returns, but they also add a certain level of volatility and risk.
- Emerging market stocks have only increased 14% since 2010, a dismal performance when compared to the S&P 500s nearly 300% growth.
What are the traits of an emerging market?
Emerging markets (AKA emerging economies) are those in development to become more industrialized. They may have attained some of the characteristics of a developed economy, but are still in progress for others.
Emerging market countries tend to have the following traits in common: low income, rapid growth, high market volatility, currency swing, and high potential returns.
- Low income: Emerging market nations often depend on agricultural activities. This contributes to their low- to middle-income per capita.
- Rapid growth: The governments in emerging-market economies focus on policies that encourage rapid growth and industrialization. In developed countries like the U.S., early industrialization can mean slower rates of economic growth.
- High volatility: Emerging markets are volatile due to numerous factors, including political instability and the risk of low liquidity or currency fluctuations.
- Currency swings: The value of the emerging market countrys currency may experience severe shifts.
- High returns: Though they may be short-lived, emerging economies offer the potential for high investment returns. These countries often export low-cost goods to developed nations to boost their GDP and stock returns.
Examples of emerging market countries
A handful of the nations most recognized as emerging market countries include Brazil, Russia, India, China, and South Africa. Together, these five nations make up what is commonly known as BRICS (an acronym for their names). Currently, China comprises 42% of emerging markets by stock capitalization.
Jim ONeill of Goldman Sachs is credited with coining the term BRIC in 2001, when it included Brazil, Russia, India, and China (without South Africa). He even predicted those four nations would dominate the global economy by 2050. South Africa joined the group in 2020.
Goldman Sachs even had a BRICS-focused investment fund which peaked in 2010, but closed in 2015 soon after oil prices plummeted. Investment experts dont tend to focus on the idea of BRICS nations taking over the worlds economy. Still, these nations continue to develop their economies.
Other countries that fall under the emerging markets label include Pakistan, Saudi Arabia, Mexico, and Nigeria.
Emerging market stocks to know about
If you’re considering reserving a portion of your portfolio for emerging market stocks, ETFs (exchange-traded funds) provide diversified exposure with relatively lower risk than individual stocks. Keep in mind that no investment is not without risk, and ETFs can vary in riskiness depending on their holdings.
One well-known emerging market ticker is the iShares MSCI Emerging Markets ETF (EEM), which tracks the MSCI Emerging Markets Index. The fund declined more than 2% in the 10 months ending November 2021, in spite of 24.5% gains by the S&P 500 in the same period. Top holdings include Taiwan Semiconductor Manufacturing Co., Tencent Holdings, Alibaba Group, and Samsung Electronics.
As of July 2021, Vanguard FTSE Emerging Markets ETF (VWO) was the largest emerging markets ETF by assets. The fund is a collection of 5,400 stocks worldwide, with a total of $115 billion in net assets. It offers strong diversification for investors, giving the largest and most liquid opportunity to invest in emerging market stocks. VWO adds top holdings like Meituan Dianping and Reliance Industries Ltd.
Second in assets to FTSE is the iShares Core MSCI Emerging Markets ETF (IEMG). Schwab also has an ETF in the space, the Schwab Emerging Markets Equity ETF (SCHE).
Here are some other emerging markets ETFs available to investors :
- iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB): An emerging-market debt ETF known for stability and liquidity
- SPDR Portfolio Emerging Markets ETF (SPEM): Tracks the S&P Emerging BMI Index, $6 billion in assets, adds top holdings like JD.com and Housing Development Finance Corporation.
- iShares MSCI Brazil ETF (EWZ): Focused on the emerging market of Brazil, $6 billion in assets, top holdings include Vale SA, Petroleo Brasileiro, and Itau Unibanco Holding.
Pros and cons of investing in emerging markets
A key positive aspect of emerging markets is they may have greater potential for economic growth than developed economies. Currently, emerging markets are projected to beat developed markets for the next several years in GDP growth, according to the International Monetary Fund. In addition, emerging markets offer diversification away from US stocks and those of other developed nations.
Still, risks are high with emerging market stocks. Due to various risk factors including political, economic, currency, and liquidity risk, emerging markets are usually more volatile than developed markets. If the currency of an emerging market country loses value, invested money when converted into dollars will also lose value.
Liquidity can be a risk factor in emerging markets. Investors may have trouble exiting an investment once they’ve put their money in.
Black swan events like COVID-19 can also pose problems for emerging market countries and investors. For example, nations like India have been hit particularly hard by the pandemic. India’s growth may continue to struggle more than previously projected.
Essentially, as trade-policy professor Eswar Prasad of Cornell University says. “Investing in emerging markets is a high-risk, high-reward proposition.”
Bottom line
As is typical of investments with high potential returns, emerging market stocks also result in higher risk and volatility. Investors can reduce the risk through diversification, which they can achieve by investing in ETFs or mutual funds. This offers exposure to emerging markets while avoiding the additional risk and effort of researching individual emerging market securities.