Market Overview

Emerging opportunities

As you’ve read above, developing nations present a wealth of opportunities to savvy investors. But with opportunity comes risk, and what makes investors savvy is their ability to maximize the former and minimize the latter. It can get complicated, but let’s start with the reasons why you might want to invest in emerging markets.

Investment theses

There are any number of reasons to want exposure to developing economies. “Seeking above-market returns” and “diversifying my portfolio” are the broad themes, but let’s get a little more specific:

• Population growth. As noted in the related article, less developed countries are gaining headcount faster than more developed ones. This means more consumers, but it also means more labor available at a lower cost. Manufacturing industry segments benefit from this trend.
• Economic growth. While an increasing population is a positive sign, it’s also nice to have rising wages. According to consultancy Economic Conditions Abroad, the Asia-Pacific region is the only one in the world where wages are projected to increase faster than inflation in 2023. India, Vietnam and China lead the list. These are the places where the middle class is growing, that is, where people who are just a generation removed from subsistence-level life are now buying homes and cars.
• Extraction. Do you know what the top oil-and-gas producing country in the world is? Would you believe, the United States? It’s true. Russia, Iran and Saudi Arabia come close, and there are plenty of others in the game. It might be more efficient to place bets on drilling countries than on specific Energy-sector companies. But let’s say you want to invest in extended-life batteries – a back door to investing in electric vehicles. The battery industry has its own back doors: lithium and cobalt. While Australia – a developed economy – produces more than half the world’s lithium, the Democratic Republic of Congo has a near monopoly on cobalt. China, meantime, extracts most the world’s rare-earth metals, which go into just about every electronic device imaginable. China also has the graphite market pretty much to itself; yes, this is the stuff of No. 2 pencils, but it has dozens of industrial applications, including nuclear reactor parts.
• Other industries. Aside from natural resources, there are two prevalent economic themes coming out of developing nations: manufacturing for export and services. Major heavy industries include machine tools, cars, ships, airplane parts and steel wiring. There will always be value in old-time smokestack factories, and you’re more likely to find them in the less economically advantaged nations. The top non-tangible industry in the emerging markets is “personal, cultural and recreational services.” This heading includes mainly entertainment, education and health care. Everything from film shoots to medical tourism to that guy on Fiverr you paid to gussy up your PowerPoint deck is covered here.
• Public policy. There are reasons why South Korea has been considered a developed nation for the past 30 years while North Korea remains an economic basket case. That’s just a stark example, but there is a broader theme here. A McKinsey study found that pro-growth government policies that support capital accumulation and economic stability often provide an edge. China – at least, pre-Covid China – led the parade here, although six other east Asian countries have seen long-term outperformance. The list of newly outperforming countries includes nations in southern and central Asia as well as the east, but it also includes Ethiopia and Belarus.
• Currency effects. “We may see the dollar losing momentum as the Federal Reserve’s rate-hiking cycle matures and as relative economic growth outside of the U.S. improves,” according to a Morgan Stanley blog post. “As the dollar potentially weakens, [emerging markets] could benefit from the relative appreciation of their own currency.” Lisa Shalett, Morgan Stanley’s head of wealth management, was looking at Latin America when she wrote that.

Playing the instruments

You can’t buy stock in a region the way you can in a company. You could purchase bonds issued by specific countries, but that is the long way around and puts you at increased risk of losing value if the host currency devalues against the dollar.

The easy way in – and out – is via an exchange-traded emerging market fund. If you’re only interested in a particular country – a big one, like China or India – these can be found. More likely, a regional fund would be appropriate. When you consider that developing economies typically grow twice as fast as developed economies, you might also think about a global fund that gives you more geographic diversification.

You can still place bets on individual companies, though. Many of these countries have local stock exchanges, although they’re usually not as liquid as the New York bourses. That’s why companies in the developing world issue American depository receipts. ADRs essentially mimic equity shares and trade in the U.S., either on exchanges or over-the-counter.

Are you playing Monopoly, or Risk?

Just because you can invest in a Congolese cobalt mine or a Bollywood film project doesn’t mean you should.

As we stated earlier, with these potential rewards comes very real risk, and we barely touched on two of the biggest: liquidity and lack of recourse. You might not be able to unload a position that you bought into because the exchange simply can’t find you a counterparty. Also, financial regulation isn’t as well-structured everywhere as it is on Wall Street. If you find yourself the victim of fraud or incompetent corporate management, there might be nothing you can do to claw back your money.

So be sure to discuss both the upside and downside with a qualified financial professional.