Investing In Emerging Markets (2024)

In July 2023, the UK joined the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, an Indo-Pacific trading bloc of 11 other countries.

Joining a group including the likes of Mexico, Vietnam, and Chile may not have a significant impact on the UK’s economic output, but the move tends to turn the spotlight on so-called emerging markets.

These are fast-growing economies which offer the prospect of potentially superior investment returns, although the risks of losing money are relatively high when compared to more established economies.

Here’s a closer look at investing in emerging markets including some of the pros and cons, options for individual investors to consider, and potential prospects for this sector.

What is an emerging market?

It’s generally accepted that an emerging market is a developing country that is on its way to gaining a more significant foothold within the global economy.

The International Monetary Fund (IMF) publishes a World Economic Outlook that classifies 39 economies (including the UK, US, Japan, Germany and France) as ‘advanced’, based on factors such as high per capita income, exports of diversified goods and services, and greater integration into the global financial system.

The IMF then brackets remaining countries around the world as ‘emerging market and developing’ economies.

Within this group are 40 other nations – including Brazil, China, Indonesia, Mexico, Russia, South Africa, and Turkey – that are deemed to be ‘emerging market and middle-income’ economies based on their higher incomes, as determined by the IMF’s Fiscal Monitor.

What may be the appeal of investing in emerging markets?

Robert Horrocks, chief investment officer at fund manager Matthews Asia, says: “Representing nearly 80% of global growth and with access to a huge and growing middle class, emerging markets can provide attractive growth prospects and potential diversification benefits for portfolios.

“Many emerging markets countries offer an attractive blend in terms of economic growth, innovation, market size, and demographics. They are, however, diverse and in different stages of development.”

Kamil Dimmich, portfolio manager of the Pacific North of South EM All Cap Equity Fund, says: “The past decade has been driven by US equities, [but] this is not necessarily going to be the case in future.”

Carly Moorhouse, fund research analyst at Quilter Cheviot, says: “Emerging markets investments provide access to long-term structural growth drivers in regions that you simply cannot find in developed markets.”

Diversification

Ms Moorhouse adds that diversification is a key benefit. “Emerging markets provide investors with access to a number of very different economies, not just relative to developed markets, but even compared with each other.

“Within one fund, therefore, it’s possible to create a diversified portfolio with exposure to a wide range of different sectors and markets.”

Mike Hollings, partner at Shard Capital, adds: “In contrast to most major developed economies, many of the countries within the emerging markets sector enjoy favourable economic tailwinds, including, a growing middle-class with increasing disposable income, low levels of personal debt, and also pension systems that are embryonic but growing strongly.

“It is estimated that close to six billion people live in countries that are currently categorised as emerging markets. That’s close to 85% of the world’s population so, if one of the objectives of an investment mandate is to target sustainable, long-term growth, then ignoring 85% of the world’s population might seem a bit short-sighted.”

Mark Hammonds, portfolio manager with the Guinness Asian Equity Income fund suggests: “Emerging markets investing doesn’t have to be a rollercoaster. They are often perceived as plays on world growth and commodity prices. But we have found companies across Asia, Europe, Africa, the Middle East, and Latin America that have both domestic and international focus, and which demonstrate persistent cash-based profitability.”

Tom Delic, fund manager at Momentum Global Investment Management, says: “There are tens of thousands of businesses listed across emerging market countries, often with very little broker coverage. This creates significant mis-pricings where businesses end up being valued at steep discounts to their intrinsic value.”

Rob Burgeman, investment manager at RBC Brewin Dolphin, says: “Emerging markets are less correlated than their more developed brethren which means they don’t all perform in the same way at the same time. Depending on the market in question, this can often prove useful defensively during times of turbulent investment performance.”

What are some of the risks of investing in emerging markets?

Matthews Asia’s Robert Horrocks says: “Investing in emerging markets is often associated with increased volatility as well as political, economic and currency risk.”

Juliet Schooling Latter, research director at FundCalibre, says: “Currency risk is a big one. It’s easy to forget that when you invest in a stock in another country you don’t just take on the risk associated with that stock, but the currency risk as well.

“Currency risk is somewhat mitigated for exporters that might receive earnings in dollars, but it is a very big factor for domestic businesses such as financials. But if you can time things right and invest in a stock and currency performing well simultaneously, it’s possible to make big returns.”

Quilter Cheviot’s Carly Moorhouse says: “There’s much greater potential for political situations to change quickly and for political parties to have a larger influence over economies, the general corporate backdrop and individual companies than in the West.

“Geo-politics is something that is always at the forefront of emerging markets investors’ minds, especially as we have all seen the impact of the war between Russia and Ukraine.

“At company level there is also corporate governance risk to contend with, which is more prevalent in emerging markets compared with developed counterparts.”

Dan Scott Lintott, fund research analyst at Investec Wealth, says: “No company, nor country, is completely immune to the vicissitudes of political action. Think anti-trust litigation in the US, or windfall taxes on oil producers in the UK.

“But the recent tech sector crackdown in China – where the government intensified the regulation of its fintech sector, impacting leading internet businesses in the country – has given investors pause for thought on further investment.”

Shard Capital’s Mike Hollings says: “Major risks include political, foreign exchange, and liquidity – the ease, or difficulty, associated with cashing in a particular investment. Counter-intuitively, they can sometimes help create attractive investment opportunities. This is because investors almost inevitably over-react and, therefore, overcompensate for these perceived risks.”

How have emerging markets performed?

The performance of emerging markets in recent times has been underwhelming. Expressed in dollars, the MSCI emerging index – one of the main barometers of performance across emerging markets economies – stands at more or less the same level now as it did a decade ago, with some notable rises and falls along the way.

In recent years, emerging markets have been eclipsed by a tilt towards technology stocks and a rampaging US market. While the developing world’s stock markets have shuffled sideways over the past 10 years, the US market – in the shape of the S&P 500 index – has soared, more or less trebling in value over the same period.

Over longer timeframes, however, results have evened up. From the end of the year 2000 until now, the S&P 500 and the main emerging markets index have produced broadly similar returns.

What are the opportunities to consider currently?

Javier Garcia, portfolio manager of the Berenberg Emerging Asia Focus Fund, says: “The biggest opportunities and benefits are in emerging Asia. We believe the markets here present a tremendous opportunity as they boast some of the highest growth rates in the world.

“The economies of Asia have changed dramatically over the last few decades. While they used to be primarily cheap producers of goods, today, they are themselves important markets for consumer goods, high-end technology, and services.”

Matthews Asia’s Robert Horrocks points to three, structural growth drivers that he believes are shaping opportunities for investors:

• Sustainability: As the world moves toward a low-carbon and sustainable future, emerging markets need to effect major economic shifts. Across renewable energy, transportation, industry, e-commerce and finance, companies that drive sustainability enjoy a tailwind of growth.

• Innovation: Research & development investment has helped emerging market companies get ahead in areas such as technology, communications, financial services and e-commerce. Increasingly, companies are targeting products and services toward their home audiences as well as abroad.

• Trade: COVID-19, conflict and supply-chain shocks have affected trade around the world. Some emerging markets, like India and Vietnam, are key beneficiaries from re-assessed global supply chains.

Mr Horrocks says: “In addition, a focus on ‘re-shoring’ (transferring a business that was moved overseas back to the country where it originated) and ‘near-shoring’ (moving a business to a nearby country instead of one faraway) drives opportunities in China and Mexico.”

Which emerging markets may appeal the most?

Quilter Cheviot’s Carly Moorhouse says: “Although it is an expensive market, for long-term investors India is still one of the most attractive in the region. With a huge, but also young population, the demographics of India are still very favourable.

“Additionally, the government has been proactive at implementing policies and reforms to improve the ease of doing business there and to attract foreign capital.

Shard Capital’s Mike Hollings also favours India, pointing out that the country has been a major beneficiary of asset re-allocation away from China: “The Indian economy is growing at just over 6% per annum and inflation is beginning to head lower, allowing the country’s central bank to adopt more dovish monetary policies. Its growth potential at least justifies higher multiples.

“In a world where investors believe the West is facing, at best, a slowdown and at worst a recession, any market which can provide evidence of realistic growth prospects over the longer term, is going to command interest and India fits that criterion.”

Investec Wealth’s Dan Scott Lintott, says: “China remains somewhat of a double-edged sword. Despite the regulatory actions of the government in recent years, it’s a country that is hard to ignore given its global economic prominence and where, arguably, the fundamentals remain strong for many companies.”

Shard Capital’s Mike Hollings says: “Latin American markets have done very well this year with Mexico in particular faring well from the ‘re-shoring’ theme.”

Berenberg’s Javier Garcia argues that three “structural megatrends” make Asia unique as a potential growth region within the wider emerging markets universe:

• ‘Techceleration’ in China, South Korea, and Taiwan: The use of data will likely grow exponentially in the coming years and the region is a leader in e-commerce innovation, 5G, and social media as well as payment and transfer platforms. Asia is also a market leader in high-end chip production and the largest semiconductor producer in the world. .

• Demographics and social change in India, Indonesia, and Philippines: The global middle class is expected to grow from around two billion in 2020 to 3.5 billion in 2030. A large proportion of this growth will be in Asian emerging countries, which should lead to a further increase in domestic demand and ultimately benefit the likes of India, Indonesia, the Philippines, and Vietnam.

• Green revolution in China: China currently produces more carbon dioxide than any other country but is also the world leader in the manufacture of solar panels, modules, and wafers, as it is – along with South Korea – for batteries in electric vehicles. Both the US and Europe want to become CO2-neutral by 2050 and China by 2060 continuing to drive massive investments in solar, wind, and hydro along with the appetite for electric vehicles.

Which emerging markets should investors consider swerving?

Shard Capital’s Mike Hollings points to China, not only the world’s second largest economy, but a country that accounts for nearly a third of the MSCI emerging markets index: “For a long-time exposure to China was almost a ‘given’ for most global investors.

“But that has changed for two main reasons. First, the Chinese government’s crackdown that targeted many of the large cap tech companies and made investors reassess and question the safety of investments in China.

“Secondly, the global lockdown caused by Covid laid bare to many, including the US, just how dependent their economies were – and still are – on China. This caused them to begin moving production centres out of the country.

“On top of these headwinds, China has had a lacklustre re-opening from Covid.”

He adds that “South Africa remains problematic”. “The country’s electrical infrastructure is falling apart with rolling ‘load shedding’ shutting down swathes of the economy.”

What are the best ways to consider investing in emerging markets?

For the majority of individual investors, the best way to gain exposure to emerging markets can be buying into investment funds that invest in the sector.

Investec Wealth’s Dan Scott Lintott says: “Emerging markets funds are the best and most efficient way for investors to gain exposure to these markets. A fund is not only cost-efficient, but will also be managed in a risk conscious manner, being able to navigate some of the inherent complexities of these markets.”

FundCalibre’s Juliet Schooling Latter says: “There are a couple of options, either via a global emerging market fund, which provides exposure to a variety of sectors, currencies, and geographies, or choosing a country-specific fund.

Quilter Cheviot’s Carly Moorhouse says: “Active management – where investment professionals make a conscious decision about which companies to include within a portfolio – is an important consideration. This is because so-called passive, or tracker, funds will, by their nature, be full of many of the types of companies that investors should be seeking to avoid in a particular region.

Which emerging markets funds do investment professionals suggest?

FundCalibre’s Juliet Schooling Latter says: “Invesco Global Emerging Markets is a fund that is worth looking out for if you want to invest in this space. It is a highly active fund that consists of around 50 best ideas across emerging markets. The fund has an outstanding long-term track record and benefits from an unconstrained, contrarian investment approach.

“It’s also worth remembering that emerging markets companies and governments need loans too, so consider bond funds such as M&G Emerging Markets Bond. This fund has the flexibility to invest across the whole emerging market bond spectrum in both government and corporate bonds, denominated in local currencies or in the US dollar.”

RBC Brewin Dolphin’s Rob Burgeman says one of his preferred generalist funds is JPM Emerging Markets Income. “It produces an income yield of 3%, with about half of its holdings split between China (27%), Taiwan (19%) and South Korea (13%).”

“For a country-specific fund I’d consider First State Sentier FSSA China Growth with top holdings including Tencent, Ping An and China Merchants Bank.”

Ben Yearsley, investment director of Shore Financial Planning, says: “I’d look at Fidelity Emerging Markets and, if I’m allowed to choose a portfolio that has well over half of its allocation in just India and China, then FSSA Asia Focus.

“I regard the Fidelity fund with its prudent, quality-based approach as a core long-term holding capable of investing in the full breadth of emerging markets economies. In contrast, India and China are the two key markets for the FSSA fund.”

Investec Wealth’s Dan Scott Lintott says: “The Hermes Global Emerging Markets fund is an excellent, core way to gain exposure. The team integrates ‘top-down’ analysis, from a country perspective, with ‘bottom-up’, stock specific analysis looking for quality companies trading at attractive valuations.

“The Lazard Emerging Markets fund is another attractive way to gain exposure, though in quite a different fashion. The team adopts a ‘value investing’ approach by looking for continuing winners of the ‘old economy’ by being overweight in traditional banks and commodities companies.”