Beyond Our Borders: Emerging Markets

Jarrett McKay - Aug 29, 2016
Investing in emerging markets, or in developing countries, is one way to increase diversification in an investor's portfolio and may provide significant opportunities in today's investing environment.

Investing in emerging markets, or in developing countries, is one way to increase diversification in an investor's portfolio and may provide significant opportunities in today's investing environment.

 

Portfolio diversification has evolved over time. Twenty years ago, diversification opportunities were much more limited in scope. For many investors, the most sophisticated geographic diversification at that time consisted of adding Japanese equities or U.S. dollar denominated foreign government bonds to portfolios.

 

Today, investors have access to many new geographies, including emerging markets, and a broader variety of products offered within these markets.

 

Why Emerging Markets?

 

There are many reasons why a look across the ocean might be worthwhile. As developed nations continue to experience slower growth, developing nations have accounted for a significant portion of global growth. Corporate profits tend to grow faster when economic growth is higher, in environments in which higher interest rates and bond yields often prevail.

 

Today, many emerging markets have free market systems or have moved towards free market systems from state-run systems. Emerging markets tend to have a large base of human capital that contributes to the workforce at a lower cost than in most developed nations. In many cases, these countries are also producing an increasing number of young, skilled workers. Some emerging markets also have lower debt levels and a larger proportion of domestic savings than developed nations. As such, they have not needed to engage in the deleveraging activities that have been necessary in North America and Europe.

 

Emerging markets often perform quite differently than developed nation markets. After the global financial crisis of 2008-2009, equity markets in China and India were among the first to enter a bullish phase and rose more quickly than those in North America. Here at home, current ongoing low interest rates have left bond yields at low levels and finding equities trading at bargain levels has become more challenging. At a time when opportunities may be limited in Canada, there may be alternatives abroad.

 

Be Aware of Risks

 

Of course, with any investing opportunity also comes risk. Emerging markets should never be classified homogenously and although many of these nations share broad characteristics that have helped to drive their growth, each emerging market has its own nuances. Historical concerns about political instability are less of an issue today than in the past, but varying geopolitical environments and other factors such as regulatory issues and local business practices may still continue to pose a risk to foreign investors.

Emerging markets have also had their share of setbacks. For example, China's economic slowdown has continued to dominate the headlines. Over recent years, India has experienced significant rates of inflation and Brazil faces challenges associated with rising consumer debt, government debt and a depreciating currency.

 

How to Participate?

 

Investing directly in the market of an emerging country may often be difficult or cumbersome. ETFs and mutual funds generally provide a diversified way of gaining exposure to these markets. Many Canadian and U.S. fund companies offer funds that invest in emerging markets for both equity and fixed income products.

 

Indirect exposure to emerging markets can also be attained by investing in multinational corporations that operate in emerging markets. As well, some non-North American, emerging market companies list their shares on U.S. exchanges as ADRs (American Depository Receipts). Benefits of investing in ADRs include the ability to trade shares using a domestic brokerage account during U.S. market hours, while not taking on additional foreign currency risk (beyond that of the U.S. dollar) since share trades and dividends are settled in U.S. dollars.

 

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