While the major equity indexes in the United States are still struggling to regain their balance, global stock markets-particularly those in emerging markets-have been having a good year.The rapid development of emerging market economies, both in size and activities, is one of the most compelling stories in recent financial market history. These relatively untapped markets offer potentially high long-term investment returns and opportunities to further diversify an investment portfolio.¹
State of the Market
Annual foreign investment in emerging markets was estimated at $192 billion in 2008, up from $8.5 billion in 1980, according to the International Monetary Fund (IMF). Most of this investment has gone to markets in Asia and Latin America, regions that have had rapid economic development over the past decade. In turn, this influx of investment capital has further fueled economic growth in these countries.
Characteristics of Emerging Markets
Emerging markets are those of lesser-developed countries, which are beginning to experience rapid economic growth and liberalization. Examples of emerging market countries include China, India and Mexico. Generally, these countries are defined by a growing population, which is experiencing a substantial increase in living standards and income, rapid economic growth and a relatively stable currency.
Asia: Profile of an Emerging Market
The potential rewards-and risks-of emerging market investing can be readily seen from the experiences of investors in Asia from late 1997 to 1999. A major collapse in emerging markets began with Asia in July 1997, when the Thai government was forced to dramatically devalue its currency, the baht. The result ricocheted throughout Asia as currencies in the Philippines, Malaysia and Indonesia came under attack from speculators. Meanwhile, financial panic infiltrated emerging markets throughout the world, from Latin America to Russia, as financial difficulties surfaced in those nations as well. Despite rescue measures directed at Thailand by the IMF, and promises of dramatic economic reform from Indonesia’s government, investor confidence failed to return to most emerging markets until 1999, when signs of economic recovery began to appear.
Lessons From Asia
After the Asian crisis, many investors began to realize there’s no “free lunch” on Wall Street-the high return of emerging markets investing comes with high risk, and many factors can trigger trouble. It is especially important to note that the fortunes of one nation can increasingly affect those of another, as trading ties become tighter between nations. As one nation devalues its currency, others may be forced to do so in order to keep their exports competitive, as some nations did when Thailand devalued the baht.
Some might ask, with such high risk potential, why invest in emerging markets at all? The answer is out-sized growth potential. The estimated average growth in the Gross Domestic Product (GDP) of developing economies was 6.05% in 2008 versus a 0.47% growth rate for developed economies. Consider also that emerging stock markets alone represent only 8.6% of the capitalization of the world’s equity markets.²
Along with high potential returns, emerging markets also offer potential diversification benefits. Because these markets may not move in tandem with those of developed countries, they may be rising while other markets are falling. Hence, they may help reduce the overall risk of a portfolio.
Based on these factors, long-term investors-specifically those with an investment time frame of at least 10 years-may want to consider allocating a small percentage of their overall stock portfolio to emerging markets, depending on their investment goals and tolerance for risk.³
- 1, 3Investors in international securities are sometimes subject to somewhat higher taxation and higher currency risk, as well as less liquidity, compared with investors in domestic securities. Past performance does not guarantee future results.
- International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
- 2Source: S&P Global Broad Market Index, December 31, 2008.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.
IMPORTANT DISCLOSURE
This article was prepared by Standard & Poor’s and is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor or me if you have any questions.
