Investors need to keep many factors in mind when considering emerging market investments, given that these markets tend to experience more volatile business cycles than their developed counterparts.
However, you don’t need to search far to discover inspiring emerging market success stories such as those of MercadoLibre or Tencent that demonstrate that with proper strategies in place, investors can navigate the often volatile emerging markets successfully.
Political risk should be an essential consideration when investing in emerging markets. This risk includes war, regulatory changes, nationalization of private companies and runaway inflation.
Emerging markets often present an inextricable link between economics and politics, often as a result of political instability triggered by external events like global trade policies changes or commodity price fluctuations. Therefore, it’s crucial to be aware of this risk and reduce it through diversification using well-established companies not tied directly to any specific nation’s political landscape.
Historically, returns on emerging market stocks were driven more by endogenous bottom-up growth factors than top-down macro factors. But with increasing political shocks quickly transmitting into asset prices and their rapid propagation across portfolios, it has become essential to include systematic approaches for political risk in portfolio management.
Emerging markets present high returns with some risks; most notably market volatility.
Market volatility measures the extent to which prices fluctuate relative to their benchmark index. A higher number indicates greater market instability.
Emerging market stocks typically experience greater fluctuations than both US and international developed markets due to the influence of commodity exports that experience their own boom-and-bust cycles.
Investors must remember that volatility is an inherent part of investing in any type of asset class, just like planning for traffic on their morning commute. Investors should anticipate and plan for volatility as part of their long-term investing strategy.
Currency can have a major effect on investment returns. For instance, when purchasing shares of a company in Brazil, your return is measured in Brazilian real (row A). Once translated back to US dollars for analysis (row C), this conversion must take place.
Many emerging market economies (EMs) rely heavily on dollar borrowing, so an appreciation of its value could exacerbate any difficulties they experience with regards to paying back loans in dollars despite changes to local currency values.
Emerging markets should form part of an investor’s overall portfolio, and they should understand both risks and rewards associated with investing there. But investors who avoid them entirely could miss out on potential returns that investing in fast-growing economies might bring. Your risk tolerance and investment goals will help determine how much of your portfolio to devote to emerging markets.
Emerging markets encompass an expansive collection of economies and markets that present both significant investment opportunities as well as unique challenges to investors and the professionals who work with them.
So-called class action securities law and fraud claims that are common in the U.S. may not be achievable due to local regulations or practices; issuers should inform investors about such restrictions.
As with emerging market companies, financial information about those located there or with significant exposure may differ significantly in frequency, quality and availability; investors should evaluate its reliability and completeness prior to making investment decisions based on such information. Regulatory agencies such as SEC and DOJ often face restrictions in taking enforcement actions against non-U.S. firms due to jurisdictional or comity considerations.
Though a well-diversified portfolio can help reduce volatility, it cannot eliminate it entirely. All investments involve risks – principal loss among them. Stock and bond values fluctuate with market conditions while international investments could be affected by changes in currency rates.
Investors should evaluate their risk tolerance, which can be defined as how much they can afford to lose – both financially and psychologically – without changing their investment habits. We recommend building a diversified global portfolio with adequate allocation to emerging markets (EMs). With their diverse range of economies and markets, emerging markets present plenty of growth opportunities; recent experiences may cause investors to hesitate but those focused on long-term returns may appreciate its potential.