Risks and Rewards: Investing in Emerging Markets

Markets in developed nations present an array of challenges to investors. These challenges are compounded when investing in emerging markets, in part because acquiring information about emerging markets is difficult. The differences between developed and emerging markets range from the sequence and method of trade to the company requirements for reporting market exchanges.

Yet, the money to be made from investing in emerging markets is often significantly greater than what can be achieved from investing in the markets of a developed nation. In addition, an altruistic aspect may exist for some investors to help fund the businesses of a nation that may still have much of its population in poverty.

Of course, the risks and rewards are also dependent on the emerging market in question. Some emerging markets are much more transparent and easy to understand than others.

Understand the Funds

The first action to take before considering an investment in an emerging market fund is to consult with a financial advisor. These types of funds are inherently more risky then ordinary stock funds, and you need to understand what you are getting yourself into when you invest.

Many investment firms have emerging market funds that focus on a basket of stocks, securities, and other financial instruments from a variety of emerging markets. Some will also have funds that focus on investments of one country. If you want to focus on one of these types of funds, consultation with an outside advisor about the wisdom of investing in them is a sound idea, rather than relying solely on the advice of someone within the investment firm.

If you do not intend to use a financial advisor and are not thoroughly familiar with the emerging market in question, do as much research as possible into the particular fund and its future plans for investment. Most emerging market funds invest in more than one country, and you need to familiarize yourself with all the countries that are part of the fund in order to have a solid understanding of what to expect from your investment.

High Growth

The biggest possible reward from investing in an emerging market is high growth. Emerging market countries tend to grow much more rapidly than developed nations, sometimes experiencing double digit growth. Therefore, investments in these countries can also grow much more quickly than can investments in established markets.

In the past, emerging markets such as Russia and China have sometimes seen annual growth in their stock markets higher than 100 percent. Of course, these growth patterns have not been consistent.

Volatility

The biggest possible risk from investing in an emerging market is the inherent volatility; the flip side of the high growth experienced by emerging markets is that the crashes can be much deeper.

Because investors do not know what to expect and are more easily surprised, panic can set in more quickly and easily than in a developed nations’ market, causing runs on capital to happen more frequently. Investing in an emerging market can be a roller-coaster ride of tremendous climbs followed by steep drop-offs.

Political Issues

Emerging markets are often in countries that have shaky political systems, so companies in those markets can be subject to the whims of whoever is in charge. In general, the more established the rule of law is, especially in respect to corporations and other investment opportunities, the safer it is to go into an emerging market.

Transparency

Emerging markets often have different reporting requirements for companies than do developed markets. A lack of oversight and regulation means that knowing the actual financial state of the companies can be difficult. You should probably choose to invest in emerging market funds where the involved companies have clear and detailed reporting requirements in order to feel safe about your money.

Liquidity

Some emerging markets have capital controls that may make moving investments out of the country challenging. It is probably best to look at emerging market funds from which you know you can pull your money out when you wish, so you are never in danger of losing your entire investment

Additional Resources

BMI Research publishes the “Emerging Markets Monitor” which contains news and information about emerging markets; it’s available by subscription at www.emergingmarketsmonitor.com.

Many investment firms offer emerging market funds, and one of the most popular is offered by Vanguard. Information can be found at www.vanguard.com.

For financial data about emerging markets, one of the best sources is available from EPFR Global which tracks global flow funds and allocation data on a daily basis.

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