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Investing in emerging markets – what do I need to know?

December 2017


Tags: Macro Economics

First used in the 1980s the term ‘emerging markets’ refers to countries which are seen as being in the transition from a developing to a developed economy.

The four largest are the so-called BRIC countries (Brazil, Russia, India and China) and in recent years a new acronym MINT has been coined to describe the second-tier emerging markets of Mexico, Indonesia, Nigeria and Turkey.

There are several benefits to investing in these markets but these are matched by risks too. The nature of the populations of emerging market countries or their ‘demographics’ are a key advantage over so-called developed economies in the UK, US and Europe which are struggling to contend with increased numbers of older people and a shrinking working age population.

 

Younger populations with more money to spend

By 2050, India’s workforce (defined as people between 15 and 59 years old) is expected to have grown from the current 674 million to a staggering 940 million.

As these economies transition from developing to developed status an increasing proportion of the population will be middle class with disposable income to spend. This is likely to result in an increase in consumer spending. A study by research firm McKinsey anticipates 76% of China’s urban population will be middle class by 2022 (http://www.mckinsey.com/industries/retail/our-insights/mapping-chinas-middle-class).

However, emerging markets carry the risk of being more volatile than developed markets, with factors such as possibility of war, tax increases, change of market policy, inability to control inflation and changes in laws regarding resource extraction. Major political instability can also result in civil war and a shutdown of industry, as workers either refuse or are no longer able to do their jobs. 

 

What role does currency play?

Volatility in emerging markets’ economies and shares is often matched by their currencies. If, for example, an investment in a Brazilian stock is made using the Brazilian real and said stock rose 5% but the real fell 10% you would still experience a net loss when selling your investment and converting it back into pounds. 

The solution to these problems could be to invest through traditional funds and exchange-traded funds (ETFs) which can help to protect against currency risks and can achieve this in a number of ways. For example the fund may invest in assets in a range of different currencies, helping to spread the exchange rate risk. The fund may also undertake some currency “hedging”, which is a common way to minimize or eliminate foreign exchange risk by using something called forward contracts, which locks in an exchange rate for a transaction that will take place at a future date.

Learn more about ETFs

Writer: Tom Sieber Tags: Macro Economics

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Selftrade does not provide investment advice. This article is the authors view and is not the view or opinion of Selftrade and Selftrade accepts no liability for any loss caused as a result of the use of this information. The opinions expressed are those of the author at the time of writing and should not be interpreted as investment advice.

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