Brazil, Russia, India and China are considered ‘drivers of future growth’ and are fast on their way to becoming the main engine of global development.
The term ‘emerging markets’ is widely attributed to former Wold Bank economist Antoine van Agtmael, who coined the term in the 1980s to describe those countries that were undergoing a period of rapid growth and industrialisation. The term was a welcome alternative to the many other less flattering phrases that were prevalent at the time, such as ‘Less Economically Developed’. The term soon caught on and, in our view, better conveys the dynamism and hope present in those countries that are on the eve of development.
Today, the term is ubiquitous and used frequently within the worlds of business and economics. It has also become the term to describe an extremely popular asset class: emerging-market equities. The success of emerging-market equities as a destination for investment capital can be explained by two key factors, namely performance and diversification.
Emerging markets are fast on their way to becoming the main engine of global growth. Over the past decade, countries such as China, India and Brazil have grown at average annual rates that have far surpassed those of developed markets. Importantly for equity investors, this impressive economic growth has translated into increased corporate profits. This makes them attractive as a long-term investment, though facing some near-term risks.
As the developed world pays down the mountainous debt pile it built up during the boom years, emerging markets will likely continue to be the key driver of global growth for some time to come. The International Monetary Fund estimates that emerging market economies will grow at a trend rate almost three-times faster than developed economies like the US and UK.
So which countries are classed as emerging? Perhaps the most famous are the so-called BRIC countries. The acronym BRIC stands for Brazil, Russia, India and China and was first used by Goldman Sachs in a now seminal paper which predicted a shift in global economic power away from the Group of Seven (or G7) major developed economies towards the developing world.
The BRIC countries are among the largest and fastest-growing emerging market countries and have received much interest from investors. The success of China, which according to some analysts could overtake the US as the world’s largest economy by 2027, has been particularly well documented and hardly needs further explanation.
Other emerging markets, as defined by index providers MSCI and FTSE, include Chile, Colombia, Czech Republic, Egypt, Hungary, Indonesia, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, South Africa, South Korea, Taiwan, Thailand, and Turkey. Of these, South Korea seems to be on the verge of being upgraded to developed-market status, while countries like Morocco and Pakistan are towards the riskier end of the scale. And this is an important point. Like anything in life, the benefits emerging markets provide come with a price. That price is higher risk.
In recent years, emerging markets have suffered a succession of macroeconomic crises – including the 1994 Mexican ‘Tequila’ crisis, the Asian financial crisis in 1997-8, the 1998 Russian financial crisis and the Argentine economic crisis in 2001-2. And while they were less adversely affected than developed markets by the 2008 global financial crisis, and have recovered more quickly, emerging markets were not immune. Furthermore, some key emerging markets face challenges unique to their domestic economies, such as controlling inflation in India and managing a property-price bubble in China.
Other important considerations include market infrastructure characteristics such as liquidity, or availability of buyers and sellers (emerging markets are typically less liquid), and transparency (company accounts can be opaque). Alongside the risks, though, there is huge potential to generate returns. Emerging-market equities can be a highly rewarding experience and should be a consideration for most wealth-generation strategies. It is, however, imperative to invest alongside experience and knowledge, for there are many pitfalls awaiting the unseasoned investor.
Valuation measures, such as the ratio of prices to earnings, are currently low relative to both their historical average and to developed markets, reflecting the general perception that emerging companies are more prone to sharp setbacks and riskier to invest in than their developed market peers. However, these perceptions have been gradually changing.
The shift in the balance of global economic activity that drove a huge outperformance of emerging versus developed markets in the first decade of this century looks set to continue over the next five years or so, as many of the major Western economies continue to struggle with a debt hangover in the aftermath of the global financial crisis.
In the second half of the 20th century, the living standards of Asian and emerging economies started to converge with those of the major advanced economies, most notably Japan and the East Asian ‘tiger economies’. This trend spread further in the late 20th and early 21st centuries, above all to the Asian giants of China, India and South Korea. Even prior to the global financial crisis, starkly divergent growth rates accompanied the convergence of income per capita between the developed and developing world.
With the great convergence in living standards likely to continue for years to come, encouraging a wider divergence in growth between the emerging and developed worlds, the term ‘emerging markets’ is fast becoming something of a misnomer.
By Will Rugg, Coutts Investment Writer
