Guide to emerging markets

Mark Atherton

Emerging markets are no longer an exotic afterthought for most investors.

Until recently, most financial advisers would tell clients that they should not put more than 5 per cent of their money into the sector. But that advice is starting to look outdated, as emerging markets, which are made up of the world's developing nations, already make up 11 per cent of the world stock market index.

The history

When the term emerging market was coined in 1986 by the International Finance Corporation, a subsidiary of the World Bank, there were only six such markets that were open to foreign investors. They were Mexico, Singapore, Malaysia, Hong Kong, Thailand the the Philippines. Today there are more than 50, ranging from Cambodia to Brazil.

Performance

One of the things which has catapulted the sector to prominence is the outstanding showing of emerging markets funds. Global emerging markets funds have, on average, doubled investors’ money over three years and trebled it over five - better returns than those achieved by any other sector.

Funds that are basically emerging markets funds also dominate other sectors. The top three Asia Pacific funds are all China funds, while the top ten in the specialist sector contains four Latin American funds and one Russian fund.

Future prospects

When you look at the demographics, it’s not hard to see why investors are so excited about emerging markets. They already contain 80 per cent of the world’s population and create 50 per cent of the world’s gross domestic product (GDP).

By 2050 the BRIC economies of Brazil, Russia, India and China will all be among the world’s half-dozen biggest, along with the US and Japan. China is expected to have overtaken the US to become the most powerful economy on earth.

The BRIC economies

All are enjoying strong economic growth, with China leading the way at an annual rate of nearly 10 per cent. It is benefiting from the Olympics effect, huge spending on infrastructure and has a fast-growing middle class. India, too, has a large and growing middle class and some world-class companies. It is also starting to spend large sums on infrastructure.

Russia’s wealth has soared thanks to higher oil and gas prices and is now starting to feed through to domestic spending. Brazil, meanwhile, is enjoying a boom in agriculture and commodities as it strives to meet massive demand from countries such as China.

However, there are negatives to consider. There are potentially damaging splits between the rapidly modernising cities and the rural hinterland in all four BRIC nations and there are concerns over the future political direction of Russia and China in particular. There is also a danger that some emerging economy stock markets have overheated after rising very far, very fast. For example, the Chinese stock market has fallen by about 50 per cent from its peak last year.

The frontier economies

Countries such as Botswana, Latvia and Panama are now part of the latest wave of economies to appear on the radar of emerging markets funds. Not as well known or well developed as mature emerging markets such as Singapore or Hong Kong, these frontier markets are the latest high-risk, high-reward opportunity.

Ways to invest in emerging markets

The best way in is through an emerging markets fund or investment trust. There are now several dozen to choose from, as well as more specialist regional funds, such as Latin American funds, or single-country funds, such as those investing in China or India. Perhaps the best known, as well as the oldest, is the Templeton Emerging Markets investment trust.

However, remember that investing in emerging markets is high-risk and sharp short-term falls in value can take place.