On June 20, 2018, MSCI, a leading global equity indices provider, upgraded Saudi Arabia to emerging market status. The investment bank UBS says this decision could attract up to $45 billion in capital to Saudi Arabia. Of this inflow, passive investors would contribute $10 billion and active ones would account for $35 billion. Another $5 billion could come from the Financial Times Stock Exchange’s decision earlier this year to include the kingdom in its emerging market index.
These predictions seem promising. However, some investors wonder whether investing in emerging markets is a good idea.
Instability. High-risk. Uncertainty. Misinformation. Corruption. While these words may describe the business environment of some emerging markets, such descriptions are the exception rather than the rule. In actuality, the risks of doing business in an emerging market, while present, are not nearly so dramatic.
Harvard Business School Professor Felix Oberholzer-Gee, when asked about doing business in emerging markets versus developed markets, stated “The first thing that struck me (when researching the topic) is the very many respects that business in emerging markets is just business.” In other words, there are fewer dissimilarities between emerging and developed markets than one may think.
Investors need to proceed with caution though. Human error and a lack of oversight, including poor research, lack of planning, or bad decision-making, can multiply the risks of investing in an emerging market many times over. However, with the right preparation, and the willingness to accept some risk of financial loss (and planning for such), one can indeed benefit from emerging market opportunities.
Here are four essential things to consider before investing in any emerging market:
Know the inherent risks.
There is no way around this fact: investing in emerging markets is typically more risky than investing in developed ones. These risks, of course, vary by country, investment type, and market sector. The fundamental principle, however, remains the same: a thorough understanding of risks—at both the macro- and micro-level—before investing is vital. According to Investopedia, the most prevalent risks that investors must evaluate include the following:
– Political and legal risks (for example, corruption and investor protection)
– Poor corporate governance structure
– Difficulty raising capital
– Lack of liquidity
– Foreign exchange risk
Understand momentum and valuation.
Given the relative volatility of emerging markets, it is critical to gauge a country’s momentum and valuation. Of course, this is not a perfect science either. Consider Asia: its emerging markets averaged a rate of return of 43% in 2017. But how much of that 43% increase is attributable to China’s strong performance? Will growth taper off in the next year or two?
Meanwhile, Latin American and European emerging markets are perceived as undervalued by many analysts. Thus, there are probably some very profitable markets to be discovered—and on the cheap.
There are plenty of uncertainties concerning momentum and valuation; this is why it is so important to remain informed of the latest market news and developments.
Consider an ETF.
When it comes to investing in emerging markets, plenty of opportunities to test the water exist. Exchange-traded fund (ETF) investments are one such way. ETFs exist for those who want more of a hands-off approach, and less risk.
Performance-wise, an ETF offers a higher return relative to risk than most other asset classes. According to Morningstar, the MSCI Emerging Markets index generated 37.75 percent in cumulative gross returns in 2017, beating Standard & Poor’s 500 index, which only returned 19.42 percent.
Remain informed, but not jumpy.
Some leaders fail to make contingency planning a priority when investing in emerging markets. Instead of paying attention to external risks, they focus on competitive risks and internal execution. This is not a very good recipe for succeeding within one’s industry, much less outside of one’s borders.
It’s one thing to identify and capitalize on a good investment; it’s another to remain on top of what’s going on with it. Given the inherently riskier nature of emerging markets, it is smart to stay tuned to the goings on within those markets. But it isn’t necessary to be anxious and jumpy, unless given a good reason.
Remember, any investment, regardless of the market, carries a risk of financial loss. Provided that you do your homework and stay on top of things, there is an excellent chance that your investment will, at some point, pay off.