Inflation has been a hot topic in recent months. Recent economic data shows that consumer prices and production costs are reaching their highest levels in decades.
With the central banks looking to raise interest rates to quell inflation, the equity strategists are getting rattled on how best to position themselves in the market.
This is happening amidst a growing perception that stocks may be overvalued. Stock indexes have been flirting with record highs. The S&P 500 has set 51 new all-time highs this year. Strategists see this as a sign of imminent correction in the market.
Emerging markets present a unique investment opportunity for investors looking for high yields and cheap asset valuations. They are also a viable means for portfolio diversification as investors look to hedge risk.
However, emerging markets (EMs) are largely uncharted territory for global investors ― and judging from portfolio allocations of portfolio managers, it seems that many are touching this asset class with a long pole.
Though EM equities come with a higher risk than their developed peers, over time they can be a source of growth and diversification in a portfolio. This article sheds a spotlight on emerging markets and how investors can gain exposure to them.
Emerging markets are economies of countries that are not underdeveloped, but not yet fully developed. An emerging market is usually a developing nation that is on the path to becoming a developed market. They may exhibit some characteristics of a developed market but are yet to reach their standard. Emerging markets are countries that have morphed from simple agrarian societies to highly industrialized states.
The prevailing misconception is to think of rich or technologically advanced nations as being developed markets and poorer, less technologically developed countries are all emerging markets.
However, what really defines a developed or emerging market is how developed the stock market is. This explains why there are rich nations that are still classified as emerging markets e.g (Qatar or South Korea) alongside poor countries such as (Bangladesh or Pakistan).
As the emerging market economy grows, its financial market becomes more integrated with the global economy, as exemplified by increased liquidity from foreign investors.
There are a variety of benefits that investors can enjoy if they invest in emerging markets. Let's have a look at some of them.
Diversification: Emerging markets are a viable means for portfolio diversification. Adding emerging-market assets to your portfolio limits your exposure to developed markets thereby reducing your risk.
Cheap assets: Compared to their counterparts in developed markets, assets in emerging markets are dirt cheap. This is because the currencies of most emerging market economies are weaker than the dollar. This provides an opportunity to tap into the growth trajectory of emerging economies
Growing economies: The most obvious advantage of emerging market investments is the high growth potential of their economies. The pace of growth in emerging markets is projected to surpass growth in developed markets in the next few years.
Almost 90% of people below 30 years of age globally reside in emerging markets. Such a young labor force can set the motion for stronger labor-market growth, increased productivity, stronger GDP, and corporate profits over time.
The IMF forecasts that by 2050, 53% of the global GDP would come from emerging markets. This makes them a tempting investment option for bargain hunters.
High yields: When compared to assets in developed markets, emerging markets have a higher yield. Within the past year, emerging-markets equities have outpaced that of developed markets. This could boost portfolio returns for investors
High volatility: Assets in emerging markets are more volatile and less predictable than assets in developed markets. The price action of assets can be sharp and quick, thereby causing significant losses.
Political risks: Most emerging countries do not have strong political institutions. Governments do not follow due process and can change laws and policies arbitrarily. Such an unstable environment negatively impacts investments.
Liquidity risk: Due to the low trading volume, not all assets in emerging markets are liquid. Even yet some markets place limits on foreign participation, while others do not have adequate investment vehicles.
This can be a source for substantial loss as sell orders cannot be filled at the current market price.
Currency risk: Currency valuation is a critical risk for investors hoping to diversify into emerging markets. Flawed
monetary or fiscal could capitulate the currencies of these nations, thereby stunting economic growth and sending the value of assets lower.
Invest in low-risk assets
Because emerging markets are highly volatile, investing in low-risk assets is an effective way of hedging against losses. Rather than investing in equities, investors can invest in bonds or ETFs to reduce the propensity of loss.
Invest in actively managed assets
Another way to hedge against risk and volatility in emerging markets is investing in assets that are actively managed. Investment vehicles such as mutual funds or actively managed ETFs are a viable way of gaining exposure to emerging markets. Being actively managed means that fund managers would be adjusting their holdings according to prevailing market conditions to reduce potential losses.
Invest specific countries
Not all emerging markets have the same growth trajectory. Some are further ahead of the curve than others. Likewise, some countries are relatively more stable than others. As such, when investing in emerging markets, you should go for countries that have consistent economic growth and stable political climates.
Invest in specific regions
Investors can consider a broad-based approach to gaining exposure to emerging markets. Rather than invest in individual securities or countries, investors can invest in regional assets. For example, the Asian Cubs ETF caters to assets in Southeast Asia. By investing in regional assets investors can spread their risks and diversify their portfolios.
Emerging markets are growing economies with a lot of volatility. It's a suitable choice for investors who want to diversify from assets in the developed market. Though they have the potential of scoring higher returns in investments, their volatility is a critical risk factor. The strategies outlined above can help you limit your risk and exposure. By investing in safer assets that are actively managed, investors can optimize gains from emerging markets.
Photo by Marten Newhall on Unsplash
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