Investing in Emerging Markets

Economic globalization has abolished trade and investment barriers, and has integrated global supply chains. In this context, emerging markets have become the new “rich industrial countries,” distinguishing themselves from developed markets and playing an important role in the global economy.

Defining an emerging market

Broadly defined, an emerging market economy (EME) is an economy with low to middle per capital income, characterized by the transition from a centrally-planned economy to a fully-functioning market. This transition is typically a complex economic process. For instance, in ex-Communist countries explicit state orders would define production and distribution, quantities of raw materials and services and distribution channels, leading to a huge surplus of undistributed goods and a huge shortage of products. This created the need for an economic reform in the countries of the former Soviet Union and Eastern Europe.

The aim of transitioning from a closed-market to an open-market is to build a stronger economy that can attain higher performance levels as well as capital market transparency and efficiency. Typically, EMEs show signs of economic development in their financial markets, banking system and regulatory bodies and are able to reach maturity in their economic structure. This is mostly demonstrated in a stable monetary system that can build consumer confidence as well as in the increasing rate of direct foreign investment (FDI). A growth in FDI indicates that the emerging economy can support the flow of international capital flows and add volume to its stock market through long-term investments.

In addition, emerging markets often serve as outsourcing outlets where developed economies can expand their operations and build new factories at a lower cost. In the recipient country, employment rate increases and managerial skills are more sophisticated as a result of technology transfer. This leads to an increase in the gross domestic product of the EME as production levels increase.

Investing in EMEs

EMEs are volatile and risky. However, the main reason why investors should consider EMEs is their high returns on investment. Statistics show that the highest returning equities are typically traded in the fastest growing economies rather than in the developed ones. Most investors prefer ETFs that are safer than stocks as they diversify risk by combining stocks from different countries and sectors in the same portfolio. In doing so, EMEs offer a controlled range of risk exposure mostly because they invest globally. By adding emerging market stocks or funds to a growth portfolio, investors can enjoy higher returns with a balance of developed market stability.

Overall, EMEs are worth exploring. Typical examples of emerging markets that are fast-growing economies are China, India, Russia, Brazil, Egypt, Mexico, the Czech Republic, Turkey, South Africa and others. Apparently, EMEs vary from very big to very small countries, represent nearly 20 percent of the world’s economies and are considered “emerging” as a result of their embarkment into economic reform programs.