How to invest in emerging markets
Investments in emerging markets - economies like those in Brazil, Russia, India and China - are an essential part of any diversified portfolio. Here we look at why they are essential and how you can get exposure.
Emerging markets will already be on the radar of any risk-aware investor. They are easy to access, tracked by multiple indices, and offer the possibility of unusually high returns. They are an attractive asset as part of a diversified portfolio.
So how do you invest in emerging markets safely?
Understand the difference between ‘developed’, ‘emerging’ and ‘frontier’ markets
Global markets are generally classified as ‘developed’ (eg France, Canada, the US, the UK), emerging (eg China, Russia, Brazil) and frontier (eg Mauritius, Lithuania, Tunisia). While developed markets represent the most sophisticated and stable economies in the world, emerging markets are not quite as established, and more prone to volatility. Frontier markets are even smaller and less accessible, and may be more vulnerable to socio-economic factors.
These definitions are made by global analysts and indices such as S&P, Russell, Dow Jones and MSCI, as well as development agencies such as the International Monetary Fund (IMF). Generally speaking, in order to be considered for ‘emerging’ status, there has to be a strong regulatory system in place and complete stock market transparency. It is believed that these factors will reduce uncertainty for investors, making emerging markets a somewhat safer bet than frontiers.
However, it is worth noting that not all ‘emerging’ markets are created equal. For instance, while the IMF and MSCI classify Pakistan as an emerging market, Russell, Dow Jones and S&P do not. And while Qatar has emerging market status from both the MSCI and Dow Jones, it is still considered ‘frontier’ by the IMF, S&P and Russell.
Before you invest, make sure you know what markets you are being exposed to. This is especially important if you are investing in a generic EM fund, which may allocate money to a variety of markets, at the fund manager’s discretion.
Know your global politics
Every market is at risk of geo-political turmoil, but emerging markets are more vulnerable than their developed counterparts. Natural disasters, political uprisings, and international sanctions can all wreak havoc with a country’s economy, causing your investments to plunge in value overnight.
Argentina was famously downgraded from ‘emerging’ to ‘frontier’ market status in 2009, after a slew of political scandals led to currency depreciation and restrictions on the in-flow and out-flow of capital. In hindsight, Argentina’s downgrade was a long time coming, and canny investors would have spotted the warning signs and withdrawn early.
It pays to take an interest in global politics and to keep an eye out for any potential disruptions. Likewise, a strong economic outlook and stable democracy might encourage you to invest more money in a particular market.
What are the BRIC countries?
Brazil, Russia, India and China are the BRIC countries and they have all posted periods of strong growth over recent years. There are a number of funds and ETFs which focus solely on these countries.
BRIC growth has slowed in the past couple of years, thanks to the falling price of oil (which has particularly impacted the Russian economy), lower commodity prices (Brazil), and rising consumer debt (China). However, according to the MSCI BRIC Index, they still returned 29.5% in the year to 31 May 2017.
However, it’s definitely looking beyond the volatile BRICs when investing in emerging markets. The likes of Poland, Czech Republic, Chile, and Malaysia may offer greater stability and less volatility.
Investing in emerging markets
- Use your ISA allowance
While the risks are higher with emerging markets, so are the rewards. As of June 2017, the PowerShares FTSE RAFI Emerging Markets UCITS ETF had returned more than 34% over the previous 12 months. That means that if you had invested last year’s ISA allowance of £15,240 in the ETF in June 2016, you would have made £5,181.60 in one-year profit.
The only way to avoid capital gains tax on EM earnings is to make all your investments through a stocks and shares ISA, so look for ISA-ready ETFs (such as the PowerShares FTSE RAFI Emerging Markets UCITS ETF), and take full advantage of this year’s ISA allowance of £20,000.
- Keep your fees low
Emerging markets investments are a relatively specialised area, so fund managers can charge hefty fees for their expertise. For instance, EM guru Mark Mobius charges 1.2% in annual fees on his flagship Templeton Emerging Market, whereas most ETFs charge less than 0.5%. If you are investing your entire ISA allowance of £20,000, this can mean the difference between a £240 annual bill, and a £100 bill, regardless of performance.
ETF investments are a great way of keeping your fees down, but it’s important to remember that they only follow ‘passive’ strategies, where your money tracks various markets automatically. When you pay to invest through a fund manager, you are paying for their expertise and alleged ability to predict market movements before they happen.
- Think long-term
These are ‘emerging’ markets, not ‘emerged’. Some are on the cusp of achieving ‘developed’ status, while the rest are considered to be full of potential. Economic growth doesn’t happen quickly, so look at this as a long-term investment. By taking a five- to ten-year view on your emerging markets investments, you can afford to ride out any volatility, and cash in on the inevitable growth of future super-powers such as China and India.