When discussing investment solutions with clients, the question of opportunities and considerations when investing in emerging markets (EMs) often arises. In this article, we delve into the unique dynamics of these markets, their structural characteristics, and investment implications.
The characteristics of EMs
EMs are usually developing nations that are characterised by rapid growth and industrialisation. These countries are transitioning from a less-developed to a more modern economy. While EMs often involve greater investment risks, they can be an area of interest for those seeking growth opportunities beyond developed economies. EMs typically include countries in Asia, Africa, Latin America, and parts of Eastern Europe, with some prominent examples being the BRICS nations (Brazil, Russia, India, China, and South Africa), and countries like Mexico, Indonesia, Türkiye, etc.
While these markets offer the potential for higher returns, they also come with greater volatility and risks, such as political instability, currency volatility, and less developed financial systems vs developed economies. Nevertheless, their allure lies in the possibility of significant growth and attractive returns for investors. Understanding their unique dynamics, structural characteristics, and investment implications is essential for navigating these markets successfully and capturing their long-term growth potential.
The case for EMs
EMs can deliver higher economic growth rates compared to developed markets (DMs). With expanding populations, a growing middle class, and rapid industrialisation, these countries can provide access to new consumer bases and innovative business models. For investors, exposure to these markets not only offers the potential for higher returns but also diversification benefits, as their economic cycles do not always move in line with those of DMs, providing a cushion against market volatility. For example, economies such as China, India and Vietnam have demonstrated robust GDP growth, driven by manufacturing, technology, and services. Similarly, countries in Africa have untapped resource potential and growing consumer demand that could yield long-term investment opportunities.
Global EM trends
1. Slowing global growth and divergence
The International Monetary Fund (IMF) projects slower global GDP growth compared to the previous decade. At the same time, DMs such as the US and Europe face structural headwinds—ageing populations, high debt burdens—EMs continue to drive global growth. However, the growth story is no longer uniform: economies like India and Vietnam are thriving, while others like South Africa and Brazil grapple with structural inefficiencies.
2. The shift to Asia
Asia remains the powerhouse of EMs, led by China and India. Even as China’s growth slows from double digits, its transition toward consumption-led growth presents opportunities in technology, healthcare, and green energy. India, meanwhile, is experiencing a demographic dividend with a young workforce and rapid digital adoption. For global investors, this Asia-centric growth trajectory is reshaping portfolio allocations toward the region.
3. Currency volatility and US dollar strength
One of the most significant challenges for EM investors is currency risk. A strong US dollar often pressures EM currencies, increasing the cost of servicing US dollar-denominated debt. South African investors, in particular, are sensitive to these shifts, as the rand is among the most volatile major currencies. Diversification across multiple EM currencies, alongside active foreign exchange management, has become a vital strategy.
4. Commodities and the green transition
EMs are central to the global commodities story. Resource-rich countries like Brazil, SA, and Indonesia benefit from rising demand for metals such as lithium, copper, and cobalt—critical for renewable energy and electric vehicles (EVs). However, the volatility of commodity cycles requires investors to balance short-term risks with long-term green transition opportunities.
5. Rising geopolitical tensions
Geopolitics play an increasingly important role in shaping investment outcomes. Russia’s war on Ukraine has altered energy flows and food security, directly impacting EMs. Similarly, US-China trade tensions create uncertainty around supply chains. Investors are responding by diversifying exposure across regions to avoid concentration risks.
6. The rise of domestic consumption
A key driver of growth in EMs is the rise of domestic consumption. Expanding middle classes are boosting demand for consumer goods, e-commerce, financial services, and healthcare. This shift reduces reliance on exports and creates opportunities for investors targeting structural, long-term themes.
7. Technology and digital adoption
EMs are advancing traditional development stages by adopting digital infrastructure rapidly. From fintech in Nigeria to e-commerce in India and digital banking in Brazil, the growth of digital ecosystems offers new frontiers for investment. However, regulatory uncertainties remain a challenge.
Risks to consider
Despite their promise, EMs are not without their challenges. Some of the key risks investors face include:
- Political and regulatory instability: Governments may implement sudden policy changes, nationalisation, or restrictions on foreign investment.
- Currency volatility: Exchange rate fluctuations can significantly affect returns, particularly when repatriating profits in hard currencies such as the US dollar, euro, British pound, etc.
- Liquidity concerns: Financial markets in these regions are often less developed, leading to challenges in entering or exiting positions.
- Infrastructure: Poor infrastructure can lead to operational challenges for companies and slower economic growth.
- Geopolitical risks: Conflicts, sanctions, or strained trade relationships may disrupt market performance.
- Corporate governance: Transparency and investor protections due to weak regulatory frameworks may lag those in DMs.
Investment approaches
Investors can gain exposure to EMs through several investment strategies, each with a varying degree of risk:
- Direct equity investment: Purchasing shares of companies based in these emerging economies and listed on their local stock exchange.
- Exchange-traded funds (ETFs) and unit trust funds: These offer diversified exposure to baskets of EM securities.
- Fixed income: Sovereign or corporate bonds from EM issuers often offer higher yields.
- Private equity and venture capital: Investing in high-growth businesses not yet listed on public markets.
A balanced allocation that combines equities, fixed income and alternatives is a key strategy that can help manage volatility in these markets while still capturing their growth potential.
Long-term outlook
While short-term risks remain elevated, the long-term structural growth story of EMs is compelling. Urbanisation, industrialisation, rapid technological adoption, and demographic advantages may continue to fuel above-average growth in these countries. However, disciplined portfolio construction, rigorous due diligence, and an understanding of local dynamics are crucial for success.
Conclusion
EMs present a paradox: high risk alongside high reward. For investors willing to embrace volatility and conduct thorough research, they offer opportunities that may not be available in more mature economies.
A measured approach—balancing client objectives and returns through diversification, comprehensive research, and a suitable investment time horizon—can make EMs a valuable component of any investor’s globally diversified investment portfolio.
