Are developed markets more or less risky than emerging markets for investors?
11 Feb 2020
Emerging markets are often favoured by investors due to their growth potential, which is generally greater than that of more developed economies. However, not all emerging markets are created equal and investing successfully in them is not without nuance.
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Add to this low inflation and an uptick manufacturing activity globally and the outlook for emerging markets looking bright. However, investors should still tread carefully when chasing returns in these markets.
We asked Investec’s Global Investment Strategy Group to weigh in on what to look out for when investing in emerging markets.
The risks of investing in emerging markets
The risk-return trade-off of emerging markets
We asked members of the Investec Global Strategy Group (GSIG) for their take on whether, in today's world, developed markets are more or less risky than emerging markets, and what investors should consider when investing in the likes of India, Russia, Brazil and South Africa.
Developed economies are, of course, conducive to stable long-term growth, which appeals to most investors. In contrast, emerging markets can be volatile. Prof Brian Kantor, Chief Strategist and Economist at Investec Wealth & Investment SA, explains that this lack of long-term certainty is the main risk that emerging market investors must consider, along with an understanding of what countries are included in emerging markets.
“This risk must be traded-off against the potential returns offered by a specific emerging market for an investment to make sense. As developing economies are generally growing from a lower base, there can be significant upside potential. Emerging economies that apply lessons from the developed world or adopt new technologies could also leapfrog developed countries to deliver significant returns.”
As developing economies are generally growing from a lower base, there can be significant upside potential.
Prof Brian Kantor, Chief Strategist and Economist, Investec Wealth & Investment SA
What are the current emerging markets?
In contrast, many high-growth African countries are also included in this collective term, yet their fundamental characteristics are distinctly different because they lag the development seen in more mature emerging markets.
According to John Wyn-Evans, Head of Investment Strategy for Investec Wealth & Investment UK, these differences include demographics, politics and policy, infrastructure and the composition of individual economies, among others.
“Some emerging market economies are built on exports, like South Africa and Brazil which sell their natural resources to the rest of the world. Conversely, China and India are mass consumption economies. As such, each emerging economy is affected differently by shifting commodity prices, as an example. For these reasons, viewing all emerging economies through the same investment lens will miss the nuances that can impact on investment returns.”
"Viewing all emerging economies through the same investment lens will miss the nuances that can impact on investment returns."
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The biggest emerging market economies
|1. China||GDP: $14,140.16 billion
|2. India||GDP: $2,935.57 billion
|3. Brazil||GDP: $1,847.02 billion
|4. Russia||GDP: $1,637.89 billion|
|5. South Korea||GDP: 1,629.53 billion|
|6. Mexico||GDP: $1,274.18 billion|
|7. Indonesia||GDP: $1,111.71 billion
|8. Turkey||GDP: $743.71 billion|
|9. Taiwan||GDP: $586.10 billion|
|10. Poland||GDP: $565.85 billion|
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How to choose emerging market stocks?
“There is a major disparity between the composition of indices in developed and emerging markets. For example, over a quarter of the developed markets' indices are in high-growth sectors such as technology. Within emerging markets that figure is only about 16%, with the majority of these businesses focused on more cyclical and capital-intensive technologies such as semi-conductor manufacturers.”
Conversely, Wyn-Evans explains that returns from the financial sector have come under pressure of late. “This sector accounts for about 16% of global indices but comprise over a quarter of indices in emerging markets. This composition makes a material difference between valuations and returns in both of those segments.”
Given the differences in composition, sector-specific opportunities exist between emerging and developed markets, he believes.
“These differences can make a difference in the way that these markets are viewed and how they are valued, which also offers long-term opportunities.”
Five things to check for any emerging market investments
- Keep a finger on the pulse of in-country events in your target emerging market investments, as these are likely to impact local market results.
- Emerging markets are volatile by their nature – and you’re likely to achieve better results by taking a long-term view.
- Diversify across multiple markets to spread your risk across sectors and currencies
- If you prefer to invest in a single market, diversify within that market through a mutual fund or exchange-traded fund
- Choose emerging market listed securities that are traded in the world’s financial capitals for convenient investment from your home country.
About the author
Patrick writes and edits content for Investec Wealth & Investment, and Corporate and Institutional Banking, including editing the Daily View, Monthly View and One Magazine - an online publication for Investec's Wealth clients. Patrick was a financial journalist for many years for publications such as Financial Mail, Finweek and Business Report. He holds a BA and a PDM (Bus.Admin.) both from Wits University.