What is emerging markets?
An Emerging Market or Growth Market is a market where the economy grows rapidly. Usually, it has been countries that invest in additional production capacity and go from agriculture and export of raw materials to more industrialization. In connection with this, the income of the population rises, as does the standard of living. As the country has a relatively large development potential compared with developed markets, the countries can often grow rapidly for a long time.
How do emerging markets work?
It is precisely this rapid growth that is interesting because it is expected to lead to good investment opportunities. On the other hand, it is common for currency fluctuations and fluctuations in commodity prices to have a major impact on emerging markets.
China is a typical example of a growth market where the country has grown strongly for a long time and gone from being the world’s production factory and offering cheap labor to now focusing more on domestic consumption.
The country’s GDP, which is a measure of the value of all goods and services produced in the country in a single year, is now the second highest in the world, after the United States.
Why are emerging markets interesting?
They provide a spice to the portfolio and exposure to markets that are expected to grow faster than the developed markets. China is the world’s second largest economy and is home to 1.4 billion people.
India is another emerging market where we find another 1.3 billion people. In other words, a fairly large part of the world’s population lives in markets that are growing rapidly.
Rapid change and improved living standards lead to exciting opportunities for us as savers.
What percentage of one’s savings should be in emerging markets?
There is no given answer to how large a share one should have in emerging markets, or if one must have it at all. On the other hand, it provides exposure to a large part of the world’s population, whose income and standard of living are rapidly improving.
This in turn leads to exciting opportunities.
Emerging markets usually make up a little over 10 percent in a global index, so a benchmark might be 5-10% of one’s fund savings?
The risk is slightly higher than developed markets, but so is the expected return. The picture below shows how MSCI Emerging Markets has developed annually since 2005.
Should you even invest in emerging markets?
Despite the corona crisis, MSCI’s China index rose by almost 30 percent last year. Also in 2021, there are good investment opportunities in the emerging markets – not only in China, but countries such as India and Brazil also have the potential to develop well.
Emerging market stocks are also very cyclical. In concrete terms, this means that they are sensitive to how the economy develops.
Export dependence is high, and increased demand from the rest of the world is positive for the stock markets in countries such as China, India and Brazil.
In 2021, growth in the world is expected to increase sharply as warmer weather and continued mass vaccination of the population make it possible for consumption and investment to pick up speed.
This means that there is a good chance for emerging market shares in general to develop well in the coming year.
Even in the long term, the potential in emerging markets is good. In Asia, economic growth is more than twice as high as in developed countries, and the expected profit growth in companies is superior.
Countries such as Brazil and Russia have somewhat special conditions due to the high dependence on raw materials, which means that their well-being is closely linked to how commodity prices develop.
However, increased growth in 2021 is expected to be positive for demand – and the price – for raw materials.
How large a part of the portfolio should then be invested in emerging market shares?
A good starting point is to look at how large a part emerging markets make up of a world index, which is about 10 percent.
Those who believe in a strong development in the future can increase that proportion by 5 percent or more, depending on how long-term and risk-averse they are.
The fluctuations on the stock exchanges in emerging markets are often higher than in developed markets both upwards and downwards, and investments there therefore require a little extra ice in the stomach.
How to invest in emerging markets:
As a saver, keeping track of individual companies in the world’s emerging markets is very difficult, if not impossible. The costs of transactions are also high.
The easiest way to get a good exposure to emerging markets in the portfolio is therefore to invest in a fund or ETF that reflects a broad emerging market index.
In this way, the risk spread becomes good, and the risk of investing too heavily in an individual company, country or region is reduced.
The risks of investing in emerging markets
In the case of emerging markets, price fluctuations can periodically be very large, significantly larger than in developed markets. The high dependence on exports and the high proportion of cyclical sectors on the stock exchanges also means that a global recession will have major consequences for the growth regions.
At the same time, a global boom can be very favorable. Another important piece of the puzzle to keep track of is the US dollar.
Many emerging countries have debt in dollars, and thus benefit from a weak dollar. When the dollar strengthens, it is negative.
I expect the dollar to strengthen somewhat in the coming year, which may provide some headwinds, but this is well offset by the positive effects of the recovery from the corona crisis.
I view emerging market equities positively for 2022 and this is currently the only region I overweight in my investment strategies. Investments in emerging markets, like all investments in equities, involve a high risk.
The chance of success increases if you save regularly, for example through a monthly savings, and if you have a long savings horizon.
Any price fluctuations are best parried by sitting still in the boat and continuing to save monthly.