Some of the world’s largest companies come from emerging economies, such as Tencent and Alibaba with net worths o $50 billion and $500 billion respectively. Over the past decades, investing in emerging markets has become an increasingly popular trend. Investors believe that they can invest in equities that are cheap, under the assumption that the emerging economy will be developed in the future. However, the potentially higher returns also come with additional risk. If you are wanting to learn more about emerging markets, here are 3 things that you should look into.
What is an Emerging Market
Classification of emerging markets is somewhat vague and can be confusing. More generally, emerging markets are developing nations that are transitioning to become developed nations, showing growth and outpacing other less developed countries. Good examples of emerging markets are South Africa, Nigeria, Brazil, Egypt, Saudi Arabia, Pakistan, Thailand, India, and Russia. It becomes confusing as the MSCI Emerging markets index includes China and South Korea, which are both powerful and sophisticated economies. One reason for this may be the portion of the population that is low income or below the poverty line. Since emerging market countries still have much room for economic growth, the opportunity is to enter the market to profit from this growth
Currency risk
Doing business or investing in any foreign currency is going to come with some currency risk. Currency risk is the risk that the price of the domestic currency or foreign currency changes relative to the other. For those investing in emerging markets, this could mean that when your investment is converted back into domestic (local) currency, it may have depreciated ( however it could also appreciate), it could also mean that the emerging markets cost may increase due to depreciation of its currency, resulting in increased cost and lower profitably. Emerging countries tend to have a more volatile track record when it comes to currency risk and to be more dependant on the currency of others, such as the US Dollar. To assess the currency risk of an emerging country, have a look at the long-term historical graphs of the emerging country’s exchange rate to get an idea of how volatile it is. You don’t need to be a tech wizard to do this; simply visit a widely used forum with an active community – they have likely answered any questions that you may need to ask already and this is the fastest way to get up to speed. Couple this with being up to date with current economic news to get a clearer idea of the level of currency risk the emerging country is facing.
Political Risk and Corruption
One of the most important things to consider is political risk and the level of corruption in the emerging country. How stable is the government? Is it likely to be overthrown in a coup that could dismantle the domestic economy? Can the government implement its fiscal policy? For example, in many African countries, corruption has been pervasive. This hinders or prevents the government from implementing fiscal policy, as tax money is more likely to enter individual pockets instead of paying for infrastructure projects and social services. If governments cannot implement their fiscal policy, then how can they be expected to repay bonds in the future? Countries like Zimbabwe have experienced hyperinflation due to the government rapidly increasing the money supply to repay debt. Corruption and a lack of regulation can topple a thriving economy; Thailand experienced this in 1997 with the collapse of its currency.
There are many things to consider when learning about an emerging market. It’s important to understand the inherent risks of a developed market first and then to understand why the risks are increased in emerging markets. If you take a deep dive into currency risk and political risk and corruption, you are going to cover fundamental risks that are components of other risk factors. Consider economic risk, the risk that macroeconomic factors with effect an investment. The level of government debt is a macroeconomic factor that may be assessed when one analyses the currency risk. Further, when analyzing political risk, one will determine whether the emerging country has a central bank and whether the central bank is independent.
By reading this article, you hopefully have a better idea of what to consider when learning about emerging markets. We believe the two key factors covered in this article will provide you with a strong base and serve as a good starting point for learning about an emerging market.