What Are Emerging Markets?
You often see the word 'emerging' in the news or in fund names, right? What countries exactly do emerging markets refer to, and why do 'growth expectations' and 'large volatility' come as a set?
What are emerging markets
Emerging markets are 'intermediate-stage' markets that aren't as mature as developed markets but are more developed than frontier (early-pioneer) markets. By MSCI's standard, about 20-some countries are included — China, India, Taiwan, Brazil, Korea (per MSCI's classification), and others.
These countries have rapidly growing economies and considerable market sizes, but they're less mature than developed markets in terms of foreign market accessibility and institutional stability.
Investors are interested in these emerging markets' 'growth potential,' but behind it there is that much greater risk as well.
Three risks hidden behind growth expectations
To understand emerging-market investing, you need to know three representative risks.
(1) Exchange-rate risk — emerging-market currencies swing more than developed-market currencies. Even if the local stock price rises, if that country's currency weakens, your won-converted gain is shaved. In severe cases, the stock price rose but you may take a loss from currency losses.
(2) Capital-outflow risk — when global financial instability comes, foreign money tends to flow out of emerging markets first. So in a crisis, emerging-market indexes often fall more deeply and more quickly than developed-market ones.
(3) Concentration/policy risk — a particular emerging-market index has large weightings in a few big countries (e.g., China, Taiwan, India), so the whole thing can be swayed by that country's situation. The risk of abrupt political or regulatory change is also greater than in developed markets.
The country-by-country weights of an emerging-market index vary over time. Remember that the larger a particular country's weight, the more that country's individual risk is reflected in the whole index.
The volatility of emerging markets that history has shown
The large volatility of emerging markets has been confirmed many times in history.
For example, in 2015 Chinese stocks surged sharply over a short period and then plunged severely, delivering a shock across emerging markets overall. Because China's weight in emerging-market indexes is large, the plunge of one country, China, dragged the whole index down.
There have also been several 'emerging-market currency crises' in the past. These are cases where, when global interest rates rose or the dollar strengthened, money flowed out of emerging markets and currencies and stock prices collapsed at the same time.
The lesson of these histories is clear. Emerging markets carry the risk of 'can fall more sharply, more quickly' as much as the expectation of 'can rise more.' So if you invest in emerging markets, it's common to do so within a range of loss you can bear and diversified with other assets. This article neither recommends nor discourages emerging-market investing; it aims to tell you its character accurately.
Frequently Asked Questions
Q. If emerging markets have higher growth rates than developed markets, are returns higher too?
A high economic growth rate doesn't necessarily mean high stock returns. Growth expectations may already be priced in, or gains may be shaved by currency depreciation and volatility. In fact, in certain periods emerging markets have underperformed developed ones. Growth rates and investment returns must be viewed separately.
Q. If I buy just one emerging-market index, am I diversified across many countries?
It does span many countries, but with large weights in big countries like China, India, and Taiwan, it's hard to see as 'complete diversification.' If a particular country is shaken, the whole index can wobble. It's good to check the country-by-country weights within the index.
📋 Results are based on historical data; past returns do not guarantee future returns.
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