Emerging Markets: A Changing World

Individuals living in emerging market countries make up 87% of the global population, and yet the emerging market population accounts for just 45% of global consumer spending [1]. This suggests that there is potential for significant financial growth if emerging markets continue to grow in the coming years.

As emerging market countries develop both economically and societally, those living in such countries are likely to benefit from the change. This evolving dynamic in emerging market countries can lead to rapid financial growth. As a result, investors often consider emerging markets as a route for generating significant investment returns. If invested responsibly, investments in emerging markets could also help improve various features of society, such as infrastructure, technology, and healthcare. In short, there is the opportunity to ‘give back’ and help developing countries to grow further.

What are Emerging Markets?

Emerging markets refer to countries that are transitioning from a developing country into a developed one. As a result, an emerging market is one that indicates economic growth and increasingly exhibits characteristics of a developed country. The countries listed as emerging markets vary depending on the source you look at. For instance, MSCI has a list of 24 countries and Dow Jones has a list of 22, while both the S&P and the IMF (International Monetary Fund) classify 23 countries as emerging markets [2].

There are a number of countries which feature in all lists of emerging markets. For example, BRICS is a collection of five major emerging markets: Brazil, Russia, India, China, and South Africa. BRICS members are typically seen has having significant influence on regional affairs, and the association was formed in an effort to improve political relationships and trade between the largest emerging market economies [3]. Other countries typically classed as emerging markets include Indonesia, South Korea, Mexico, Turkey, and Saudi Arabia.

Many developing countries are improving their financial, technological, and physical infrastructure. This has led to increased urbanisation and higher income per capita. As emerging market economies develop, urbanisation and increased financial wealth lead to shifts in spending patterns. In low-income households, there is little financial freedom to spend on items other than basic goods and services (e.g. food). For example, people in rural India spend 55% of household income on food whereas, in the US, food makes up just 13% of household expenditure, with more money spent on leisure and goods [4]. As incomes in emerging market countries improve, many individuals will be able to increase spending on recreational activities, technology, and travel. This shift in consumer spending helps to further stimulate economic growth.

As emerging markets develop, they generally become more integrated within the global financial system. Liquidity in national debt and equity markets increases, leading to greater investment from both local and foreign sources. Additionally, regulatory institutions become more established which helps secure financial stability and maintain growth.

The Role of Emerging Markets

Some believe emerging markets indicate a changing global landscape. In western countries, population and productivity growth have slowed in recent decades. In contrast, emerging market economies are having an increasingly significant role in global growth. Contribution from emerging markets to annual global GDP growth has increased since 1985, as indicated in Figure 2.

Figure 2: Data shows the contribution by various geographical sectors towards annual global GDP growth.

A key emerging market is China, which is currently predicted to become the largest economy in the world by 2028 [5]. In contrast to the US and most European markets, China ended 2020 with a rather promising financial outlook, having recorded annual economic growth of 2.3% [6]. The consumer market in China is becoming increasingly important for corporate profits across the world. If demand for certain goods increases, then there is potential for improved trade with neighbouring countries. Forecasts by Morgan Stanley predict that China’s GDP will grow by 9% in 2021 and emerging markets will experience a growth of 7.4% [7]. Additionally, growth in various market sectors (particularly in TMT and energy sectors) can spur corporate activity in M&A deals. These features are all seen as potential drivers for growth in other emerging markets across Asia.

Of course, emerging markets are not all the same in size or structure – giants such as China and India have very different economic outlooks in comparison to smaller emerging markets such as Thailand or Taiwan. Concerns have also grown over the increasing number of debt crises in poorer countries across Latin America and Africa. Some experts have called for global institutions, such as the IMF, to help financially support and stabilise poorer nations in an effort to avert further debt crises [8, [9]](https://www.ft.com/content/3a7c6479-dc08-4383-a93d-3a4b359898a9). In any case, potential exposure to market volatility, debt crises, and political instability are important risk factors that need to be weighed before investing in emerging markets.

Investing in Emerging Markets

Investors have to be wary of the risks associated with emerging markets. As with all investments, there is no guarantee of financial returns. In the case of emerging markets, this is even more apparent, as investing in emerging market economies comes with its own sources of financial risk.

One source of financial risk is that of market volatility. Emerging markets are more likely to be affected by external price movements and generally exhibit less liquidity than global developed markets. Furthermore, emerging markets may be more exposed to political instability, which can increase volatility. Even the geography of many emerging markets means that these countries are more prone to natural disasters, and such events can cause an economic shock as well as a huge impact on imports and exports.

Nevertheless, investment in emerging markets is growing. It can provide investors with excellent diversification within their portfolios. In particular, a fund investing in emerging markets could be well-suited to investors looking for a diversified approach. For instance, a global emerging market fund might be made up of equity or debt holdings from across Asia, Africa, Latin America, and Europe.

Emerging markets can also be a potential source of long-term growth, as investors can benefit from the rapid industrialisation and urbanisation of developing countries over the coming years. Currencies in some emerging markets may be considered undervalued and so investments in such markets could provide significant returns in the long run [10].

Emerging market equities have also gained traction, particularly in the wake of Covid-19. In recent months, many have flocked to investing in emerging market stocks, partly because interest rates in developed markets reached record lows towards the end of 2020 [11, [12]](https://www.economist.com/special-report/2020/10/08/the-eternal-zero).

The role of emerging markets is likely to be further cemented in a post-pandemic global economy, given that many emerging markets have generally recovered much better than developed markets. For instance, the MSCI Emerging Markets Index outperformed global developed markets equities in 2020, as shown in the figure below.

Figure 3: Data shows 2020 equity market performance for various geographical sectors.

If emerging markets continue to outperform developed markets throughout the post-pandemic recovery, then investors may have to reevaluate the role that emerging markets play within their investment portfolios. Despite the risks associated with investing in emerging markets, investment management firms are looking to improve links to developing markets in order to be better placed to benefit from future growth.

References:

[1] https://www.schroders.com/en/strategic-capabilities/emerging-markets/infographic/
[2] https://www.investopedia.com/terms/e/emergingmarketeconomy.asp
[3] https://corporatefinanceinstitute.com/resources/knowledge/economics/emerging-markets/
[4] https://am.jpmorgan.com/ch/en/asset-management/adv/insights/market-insights/on-the-minds-of-investors/risks-of-investing-in-emerging-markets/
[5] https://www.bbc.co.uk/news/business-55699971
[6] https://www.fidelity.co.uk/markets-insights/markets/asia-emerging-markets/now-time-invest-emerging-markets/
[7] https://www.morganstanley.com/ideas/emerging-markets/
[8] https://www.ft.com/content/b9164299-5a57-4548-9204-370316f47814
[9] https://www.ft.com/content/3a7c6479-dc08-4383-a93d-3a4b359898a9
[10] https://www.schroders.com/en/mt/professional-investor/insights/markets/outlook-2021-china/
[11] https://www.ft.com/content/c58dbec6-953c-43f6-83c1-511b5ef10376
[12] https://www.economist.com/special-report/2020/10/08/the-eternal-zero
[13] https://www.lazardassetmanagement.com/research-insights/outlooks/emerging-markets