Some say it’s risky to invest in emerging markets:
I say it’s riskier to ignore them
Given that emerging markets account for 80% of the world’s population and almost 70%1 of the world’s GDP growth, this sector of the global economy is simply too big to ignore.
In spite of their size, emerging markets only account for a very small percentage of most Canadian investors’ portfolios2. In order to take the mystery out of emerging markets, we take a look at which countries are involved, what their advantages are and how they could fit into Canadians’ portfolios.
What is an emerging market?
An emerging market is the economy of a country that is developing and opening up to international markets. Emerging market countries typically share some or all of the following traits:
- Increasingly liquid equity and debt markets
- Growing international investment
- Improving regulations
- More integrated into the world economy
Which countries are considered to be emerging markets?
Several indices list emerging markets, but the countries they contain can vary slightly, holding between 22-27 countries within them. For example, the MSCI Emerging Markets Index2 currently contains these 27 countries:
|Hungary||Philippines||United Arab Emirates|
Obviously, the size of these economies varies greatly. Four of these countries — known as the BRIC category — are considered to be the largest economies and the ones expected to be the most influential among the current emerging markets. They are Brazil, Russia, India and China. China, for example, is now the second-largest economy3 in the world and could arguably be within a category of its own.
Characteristics of emerging market economies
While many of these economies can be extremely different from one another, they do tend to share some characteristics that bring both potential opportunities and some risk. These include:
- A huge shift in the population from rural to urban areas
- Low debt
- Fast growth
- A rapidly growing middle class
- Opening economies
- Typically higher volatility than developed markets
These economies are also extremely diverse. While they’re all heading in the same direction, they’re going at different speeds and with different risk considerations.
The advantages and disadvantages of emerging markets
Emerging markets are likely to grow more and faster than developed economies. By 2050, it is predicted that the three largest world economies will be China, India and the US4, in that order. China’s middle class is forecast to reach 550 million5 in three years. And emerging market economies are expected to grow around twice as fast6 as developed countries.
Emerging markets are therefore expected to bring considerably higher growth for investors than developed countries. Also, emerging markets tend to have far more undervalued securities, which gives investors more opportunities for potential higher returns.
Apart from the potential growth opportunity, emerging markets also provide unique diversification compared to developed countries. Not only do these countries generally have little correlation to North American economies, they also generally have very low correlation to each other. Plus, risk is typically spread over a large number of countries.
The main disadvantage of emerging markets is that they can be more volatile than developed markets. This can be due to a number of reasons:
- A lack of transparency
- Fewer regulations
- Political insecurity
- Closed markets
However, for those investors who are in it for the long haul, the possible benefits of emerging markets make them impossible to ignore.
How emerging markets can fit into Canadian portfolios
Emerging market equities cover a vast range of companies, with some indices holding hundreds of different stocks. Emerging market debt is usually less volatile than its equities but may still deliver a higher yield than Canadian or other developed debt. In general, it makes sense therefore to hold both emerging market debt and equities in a portfolio.
Currently in Canada, exposure to emerging markets is just under 3%7. Compare this to MSCI’s ACWI index8, which has 13% in emerging market exposure. This underrepresentation means that Canadian portfolios are missing out on considerable diversification benefits and higher return potential.
Canadian investors shouldn’t be asking themselves if they should invest in emerging markets, but rather how much they should invest. This will depend on your portfolio’s current composition, as well as your investment goals.
What comes after emerging markets?
Frontier markets are those economies that are less established than emerging markets, being smaller, less liquid and/or riskier than emerging economies. In the future they may offer considerable growth opportunities, but for now there is a lack of investment access. However, it is good to keep these opportunities in mind for the future.
Dipping your toes in emerging markets
Emerging markets offer too much of an opportunity for Canadians to ignore. And we’ve made it easy to take advantage of their high return potential and diversification: for more information, advisors should speak with your Mackenzie sales team; for investors, talk to your financial advisor.
Watch out for part two in this blog series on emerging markets: Its own allocation: China and China A-shares.
1 CFI: Emerging market economy
2 Mackenzie Investments: Does China deserve its own allocation?
3 MSCI: Emerging Markets Index
4 Nasdaq: The five largest economies in the world
5 PWC: The world in 2050
7 Mackenzie Investments: Does China deserve its own allocation?
8 MSCI: ACWI Index
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