By Aviva Investors
Emerging markets like China, India and Brazil are undergoing rapid economic transformations that may unlock investment opportunities for investors.
But remember, your investments can fall as well as rise and you could get back less than invested.
What should you expect from emerging markets?
The signs of economic development are almost everywhere in emerging markets. In places like Beijing, São Paulo and Istanbul, construction cranes dot the landscape; new highspeed rail links and airports are opening; and consumers are as likely to shop in glitzy shopping centres as they are on smartphones. As these countries develop, their economies will expand and diversify. For an astute investor with a long-term investment horizon, this is a potential opportunity for sizeable returns.
Yet with higher return potential comes higher risk. It’s important to note that economic development isn’t necessarily a smooth path and there will undoubtedly be bumps along the way. These countries may have less stable political regimes, and institutions that are less democratic and even corrupt; less established legal and regulatory frameworks; and they can be heavily reliant on commodity exports. These risks can sometimes spill over into equity markets with negative effects. As most of the underlying companies are traded on local equity exchanges and are priced in the currency of that country, negative sentiment on the currency can also negatively impact overall performance.
How have emerging markets performed?
The last few years have been challenging for the asset class as investment sentiment has remained muted, though pockets of strong inflows have been seen in areas like North Asia. Headline-dominating political challenges in Turkey and Argentina and a strong US dollar have also negatively impacted performance. Unexpected regulatory change in China often leads to negative sentiment in markets as well.
COVID-19 has also driven a wedge into performance. Countries with strong measures to combat the spread of the virus and better healthcare infrastructure have fared better. China has been a notable strong performer and has recovered quickly, whereas countries like Brazil and South Africa have faced more widespread challenges related to the virus.
Countries with significant oil and gas exports, such as Russia, and those geared towards travel and leisure, like Thailand, have also struggled. Yet countries with strong IT hardware and internet-related companies, like Taiwan and Korea, have performed quite resiliently.
Should you consider emerging markets?
One of the most common arguments for investing in emerging markets is that they often have favourable demographic profiles. A country like India has a young and growing population that should provide a strong foundation for economic growth in the decades to come.
Another commonly cited reason for investing in emerging markets is a growing middle class. Economic development tends to increase incomes which then lifts people into the middle class. When that happens, consumers begin to spend this discretionary income on consumer products, spend more on health, and begin to access a wider range of financial products.
Finally, the course of economic development doesn’t have to mimic developed countries. In many ways, these countries can ‘leapfrog’ existing technology. In China, we have seen widespread adoption of mobile payments as the dominant form of payment, outpacing payment cards.
How could you use an emerging market fund?
Given the risks, it’s important to be well-diversified in your exposure. Being well-diversified in terms of country and sector allocation is important particularly during times of market contagion: when negative sentiment starts to spread beyond the country or sector affected.
In choosing an emerging market fund, it’s useful to find a manager who considers Environmental, Social and Governance (ESG) factors in their investment process. Also, it could be wise to consider looking into fund managers who have experience in emerging markets due to the risks that the sector comes with. Investors need to be mindful, too, that there is often less corporate transparency in emerging markets.