Investing in emerging markets can make a lot of financial sense. You simply put money into developing countries, such as Brazil, China and Mexico, and then enjoy bumper returns as their companies and economies grow rapidly
If only it was that simple. Unfortunately, the above isn’t a guaranteed route to riches. In fact, it can be extremely risky because the under-developed nature of these regions makes them more susceptible to problems of a political, economic and regulatory nature.
This poses an intriguing conundrum for would-be investors. Does the chance of fantastic future returns outweigh all the sleepless nights? It’s a point acknowledged by Justin Modray, founder of Candid Financial Advice.
“You’d expect emerging markets to grow faster than developed markets over time which, in theory, means higher long-term returns,” he says. “However, the ride tends to be bumpier because they experience growing pains – and this causes greater volatility.”
Emerging markets have been on investors’ radars for more than three decades. As investors started exploring different parts of the world, there was a need for research information. This resulted in the creation of the MSCI Emerging Markets Index.
When this was launched in December 1987, it covered just 10 countries, which made up less than 1% of the global equity market. Subsequent events, such as the collapse of the Soviet Union, increased interest in these areas.
Today, the index consists of 26 countries that are becoming powerful players on the international stage. These include China, Korea, Taiwan, India, Brazil, South Africa, Russia, Mexico and Thailand.
Patrick Connolly, a chartered financial planner at Chase de Vere, believes the long-term emerging markets story looks compelling because economic growth rates in these regions continue to beat those in the western world.
“They should also benefit from greater domestic consumption over time as emerging market populations, which account for more than 80% of people in the world, have increasing levels of wealth and disposable income,” he says.
He also points out that another 2.5 billion people in these emerging areas will join the middle classes by 2030. As a result, emerging countries will increasingly focus on making goods and services for themselves – as opposed to the rest of the world.
“Their reliance on commodities and natural resources has been reducing, with the regions now having far more top-quality telecoms, technology, consumer and healthcare companies,” he adds.
However, there are potential problems to consider. While these markets are set to outpace the developed world, they remain vulnerable to political risks, sub-standard infrastructure, and poorer levels of corporate governance.
Adrian Lowcock, head of personal investing at Willis Owen, agrees. “Emerging markets can be more volatile,” he says. “Because they are historically risky, they tend to be among the first areas affected when investors become nervous and risk-averse.”
He also highlights how some regions have specific risks associated with them – which is one of the reasons why he favours funds that take a broader approach, as opposed to those focusing on just one country.
“Russia has a high political risk and there have been issues for foreign investors, while China has a lot of state-owned enterprises that are not necessarily run in the interest of shareholders,” he explains.
A report by MSCI, entitled The Future of Emerging Markets, highlights how these areas have delivered better returns – along with greater volatility – than developed markets over the past 30 years. It also acknowledged some more challenging periods.
“Recently, emerging markets have experienced volatile performance, driven by changes in monetary policy, increasing political uncertainty and deteriorating conditions for international trade,” the report stated.
However, the study concluded there were reasons for optimism, including economic growth, ongoing capital market liberalisation, the further adoption of free market policies, and the emergence of world class companies.
Richard Titherington, chief investment officer of emerging markets and Asia Pacific equities at JP Morgan Asset Management, suggests that the unpredictable nature of the emerging markets can be partly tamed by investing in quality businesses.
“Volatility is a fact of life in emerging markets – but it can be your friend,” he says.
“Having the gumption to invest against the crowd can throw up great opportunities, as long as you have the time horizon and process to back your conviction.”
There are clearly pros and cons, but emerging markets are still worth considering, according to Justin Modray at Candid Financial Advice, who favours low-cost tracking portfolios, such as the Vanguard Emerging Markets Stock Index fund.
“The key is to only take as much risk as you are comfortable with,” he says.
“Emerging markets tend to be more volatile than developed ones, so if you are risk-averse, you will want to keep your exposure to emerging markets low – or skip them completely.”
Fund to watch: JPM Emerging Markets
The aim of the fund is to provide long-term capital growth by investing primarily in the equities of emerging markets companies.
It may suit those with globally diversified portfolios who want to expand into riskier emerging markets.
The fund has a bottom-up approach that targets long-term investments in high quality, well managed businesses that have sustainable growth potential and a thoughtful approach to environmental, social and governance issues.
This philosophy is particularly important given the fact the fund has a generally low turnover, meaning it typically owns companies in the portfolio for longer than the usual time horizon of most investors.
JPM boasts one of the largest and best resourced emerging markets investment teams – based across London, New York and Singapore, according to Patrick Connolly, a chartered financial planner at Chase de Vere.
“This is, perhaps, as close as you can get to a pair of safe hands in what is a volatile investment sector,” he says.
“The fund adopts a long-term approach, seeking high quality companies that have consistent growth prospects.”
According to the most recent fund fact sheet, financials account for the largest share of assets under management at 41.1%, followed by the 20.2% in consumer discretionary names, the 12.5% in information technology, and the 10.4% in consumer staples.
As far as individual companies are concerned, the largest position of 5.5% in the fund is held by AIA, the life insurance group. Other prominent names include Tencent, Samsung Electronics, and Alibaba, the Chinese e-commerce platform.
JPM Emerging Markets Fund
Value of £100 invested in the fund over five years
|Fund movement in year (%)||4.82||-11.12||36.93||29.61||-11.41|
|Value of £100*||104.82||93.16||127.56||165.34||146.48|
* The £100 was invested on 1 January 2014. Source: Moneywise.co.uk
|Lead Manager||Leon Eidelman (lead) and Austin Forey (back-up)|
|Launch date||1 Feb, 1994|
|Total fund size||£1.4bn|
|Minimum initial investment||£1,000 ('A' shares)|
|Min. additional investment||£100 ('A' shares)|
|Initial charge||Nil ('A' shares)|
|Ongoing charge||Nil ('A' shares)|
|Annual management fee||1.50% ('A' shares)|
|Contact details for retail investors||0800 20 40 20|
ROB GRIFFIN writes for the Independent, Sunday Telegraph and Daily Express.