Revisiting Emerging Markets: Are They Right for You?
AFTER YEARS OF ZIGGING while the S&P 500 zagged, emerging markets appear to be making a comeback. While they trailed other equities in 2018, losing more than 15%, according to the MSCI Emerging Markets Index, they have recovered ground this year.
Several factors account for this turnaround of the 24 countries across Asia, Latin America, Europe, Africa and the Middle East that make up the MSCI Index. In the Q&A below, Ehiwario Efeyini, senior market strategy analyst, Chief Investment Office, Merrill and Bank of America Private Bank, offers his insights on the risks—and opportunities—emerging markets might represent for investors who are comfortable with volatility.
Q: Why are emerging markets doing better this year?
A: Some of the economic conditions that caused problems for emerging markets last year have improved. Stabilization in the value of the U.S. dollar since December has been a source of relief for foreign currency borrowers in many of these markets. Growth in China has also stabilized, in part due to stimulus measures introduced by the central government since the fourth quarter of last year. But most important has been the shift in the direction of U.S. interest rates. Capital flows tend to move out of emerging markets when U.S. rates rise, and the pause in Federal Reserve rate hikes has seen net positive global investor inflows into emerging markets so far this year.
DID YOU KNOW: The term “emerging markets” was coined in 1981 by the World Bank’s International Finance Corp. as a replacement for “Third World.” The intention was to capture the progress and dynamism these countries represent.
Q: Which emerging markets have been doing well?
A: Asia has been the best-performing region for much of this year—after being the worst performer last year--with China and Taiwan leading the way. Along with Korea, these are among the markets most exposed to the fast-growing technology sector, either through digital services like online retail and social networking or as suppliers of electronic components. Optimism over the prospects for a U.S-China trade deal was an additional tailwind earlier in the year. And while trade tensions between the two sides have once again escalated more recently, we still expect an agreement to be reached in the not-too-distant future.
Q: What are the major risks with emerging markets?
A: While less crisis-prone now than they were in past decades, emerging markets tend to be more volatile than developed markets. By definition, their markets are smaller and their institutions are generally weaker, so they can be more vulnerable to policy changes and other political risks—for example, international sanctions or the current trade tensions between the U.S. and China. Commodity prices, too, can have greater importance to some individual emerging markets, many of which are major natural resources producers. In general, emerging markets tend to be concentrated in a smaller number of sectors, so underperformance in specific areas can have an outsized impact.
Q: How can investors comfortable with that level of volatility invest in emerging markets?
A: Beyond investing directly in the stocks of individual companies, there are mutual funds and exchange-traded funds (ETFs) that track global emerging market indexes. You might also look at regional ETFs and mutual funds, and ETFs that track individual emerging markets countries. Other funds give you exposure to particular sectors—the consumer sector, for instance—within emerging markets.
Whatever you decide to do, talk with your financial advisor about the role emerging markets might play in your portfolio and what the right allocation is for you, given your goals, time lines and risk tolerance.
Investing in emerging markets involves risk.
