There has been a huge movement in global investing in the last 2-3 years – especially in US markets. Investors are finally realizing the importance of global investing and today millions of Indian investors are investing globally. Most of the action has been in the US due to historical track record and appeal of US tech companies. However, it’s important that investors also evaluate other markets. Let’s look at emerging markets.
Emerging markets have remained a popular investment area since their introduction in the early 2000s. Emerging markets are a unique investment opportunity as they typically are considered to offer high risk and reward ratio. While there are huge gains awaiting investors that can identify the right emerging market investment at the right time, the risks involved are sometimes not well understood.
What Are Emerging Markets?
Well there may not be an exact definition for Emerging Markets (EM), however generally speaking, economies that exist between the stages of developing and developed are considered as Emerging Markets. The emerging-market phase occurs when economies see their most rapid growth, amid higher volatility as compared to Developed Markets. MSCI (one of the world s renowned index providers) identifies 27 countries as emerging markets as of 2021.
Key attributes of EM:
Potential for rapid GDP Growth – Typically EMs are perceived to experience rapid economic growth. Over past few decades, EM’s contribution to world GDP has grown considerably from less than 30% in 1980s to almost close to 50% 2020s . There are a number of large EM markets that experience higher GDP growth rate over other EM and Developed markets globally.
Favourable Demographics and Consumption – One the key characteristic of EM markets is, its demand led by not just exports but also by domestic consumption. This is primarily possible since ~85% of worlds’ population lives in emerging markets. A whopping 90% of the world s population under age 30 is from EM and as per estimates nearly 58% of world’s middle class populations will be from EM by 2030. The growing middle class and their consumption is one the key factors in the growth of EM.
Increasing penetration of innovation and digitization – Back in history EMs were considered as a workshop of the world being a low cost manufacturer, a raw material supplier and hub for outsourcing services. However over the past couple of decades, EMs are increasingly becoming leaders in innovation, and digitization. Countries like Taiwan and Korea are leading manufacturers and suppliers of essential technology and electronics for the world.
Risk associated with EMs
The progression from being EM to becoming a developed economy may not always be smooth. EM courtiers tend to experience greater political, economic, currency and legal risk as compared to developed counterparts. EM countries generally are less equipped to manage economic losses on account of political disturbance or large natural calamities. However, if basic caution is exercised, the rewards of investing in an emerging market can outweigh the risks. Despite their volatility, the most growth and the high-returning stocks tend to be found in the fastest-growing economies.
How to invest in EMs?
Globally, investors tend to prefer investing in diversified basket of EMs countries as against specific countries to manage country specific risk which can be quite high in certain situations.
There are multiple routes to invest in the EMs such as direct equity, mutual funds or passive funds. Each route may have its pros and cons; however, a number of the retail and large investors tend to prefer the passive fund route due to ease and cost effectiveness. Any passive fund that consists of a diversified basket of EMs can be a very good starting point. It helps to eliminate stock specific or country specific risk, that too at relatively low cost.
What about China?
Referring to emerging markets without alluding to China is incomplete. Recently China has been grabbing the headlines due to its regulatory crackdowns on Real estate (Evergrande’s debt crisis) and consumer internet companies like Fintech, e-commerce, social media, gaming, Education Tech. China is a unique market as there is huge political intervention and lesser transparency but remains a bright spot in the longer term as it remains on path towards becoming the largest economy over the next decade or so. One can sail through short term volatilities arising out of a specific country by taking a basket approach to Emerging markets.
Conclusion
With India being merely 3% on the global map in terms of market capitalization, global diversification is key to making a robust portfolio. With its relatively low correlations to Indian equity, the emerging market offers an excellent opportunity to increase diversification and reduce overall portfolio risk. Emerging Markets such as China, Taiwan and Korea offer technological prowess whereas courtiers like Brazil, Russia, and South Africa are rich in natural resources, adding effective sector/industry level diversification for Indian investors.
This article was originally published on 18th October, 2021 in Deccan Herald
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