Like it or not, most investors have exposure to emerging markets through their portfolios – from global equity portfolios or investing in companies that take profits from these markets.
Emerging markets is also a broader term than BRICS – the traditional Brazil, Russia, India and China markets.
Emerging now includes several Latin American and South East Asian nations – like Columbia and Indonesia.
Simply placing an amount of money in to an emerging market fund and waiting for the cash to grow is not enough.
Emerging markets have their issues – they may be different from those of older, traditional markets in Europe and the USA, but inflation, rates of GDP growth and rising energy costs hold sway in every nation.
Trends driving economic growth
According to Jonathan Smith of investment fund managers Schroder’s, investors have two reasons for looking at emerging markets.
- Emerging economies will continue to grow faster than developed markets. Investors can exploit this growth to achieve a higher return than by investing in developed markets alone
- Investing in emerging markets increases asset diversification
His advice was aimed at pension funds – which, he suggests, are more likely to find the first reason the most compelling argument for investment.
Smith also explains a long term investor needs to distinguish longer term (secular) drivers of growth in emerging markets from shorter term (cyclical) drivers.
A number of secular trends are driving growth in these economies:
Demographics: In most western nations, working age population is falling, as people live longer and birth rates fall. Emerging economies have a larger working population, that means a more economically productive population and greater potential for economic growth.
Fiscal strength and policy improvements: Strong government balance sheets mean that many emerging economies are at least as robust as developed economies.
These governments can borrow domestically, as wealth increases and citizens and institutions look for somewhere to place their cash. Domestic borrowing reduces currency and refinancing risk and promotes economic confidence. Improved inflation targeting has also boosted investor confidence.
International trade: Emerging market economies need natural resources to grow, which are often supplied by other emerging market countries. For example, as China and India expand their infrastructure, they often turn to Brazil and Russia for commodities and energy. Competitive labour costs and more stable currencies also boost trade with developed markets.
Consumption: Rising household incomes increase spending, particularly on discretionary items such as luxury goods, cars and electronics, many of which are produced domestically. This also promotes economic growth.
Opportunities for investors
“There are many reasons to believe that emerging market economic growth will continue to outpace developed market growth in the long term,” says Smith.
“However economic growth does not guarantee investment growth. Furthermore, greater integration of emerging markets with developed markets has limited the diversification benefits of some emerging market investments.
“As emerging markets continue to expand, so does the range of opportunities for investors. There remains a strong case for a separate emerging markets allocation within a portfolio.”