How to invest in emerging markets

What is an emerging market?

‘Emerging markets’ is a term that is widely-used but loosely-defined. Emerging markets are economies that show some of the traits of developed economies but aren’t quite at the same level yet.

There are three categories of economies: developed or advanced, emerging and frontier. An emerging market economy is considered to be progressing towards becoming advanced, with regulatory bodies, a market exchange, and some liquidity in its debt and equity markets. However, it doesn’t have the same level of regulation, oversight or market efficiency that an advanced market has. This means they are defined as emerging markets not only by the way the economy is performing but how it is being reformed and developed. An emerging market grows faster than an advanced one, but an advanced market delivers steadier, more reliable growth over sustained periods of time.

A frontier market is the stage before emerging and is used to classify smaller developing countries that have yet to be recognised as having an emerging economy. These tend to be the poorest countries that are either not experiencing rapid growth or attempting to open up the economy.

What are the characteristics of emerging markets?

In a nutshell, the defining characteristic of an emerging market from an investor’s point of view is that they offer faster growth than advanced markets, but they also carry more risk and tend to be more volatile. Below is a list of some typical characteristics:

• They are going through a period of industrialisation and experiencing above-average economic growth
• But with below-average per capita income (relative to advanced economies)
• They have fast-growing populations and an emerging middle-class
• Their currency tends to be exposed to more volatile swings with currencies of advanced economies, particularly the US dollar
• But they are often trying to reform their exchange rate mechanisms to increase the stability of their currencies to discourage citizens from sending their money overseas and encourage investment from abroad
• They also tend to be vulnerable to swings in commodity prices like oil or agricultural goods
• They have implemented plans to reform the economy, usually toward an open market one that engages more with the rest of the world
• They are attempting to introduce greater accountability and transparency into the economy and financial system to build confidence among foreign investors

What countries are the largest emerging markets?

Global organisations such as the International Monetary Fund (IMF) and the World Bank - as well as the numerous index providers that track emerging markets - follow different definitions and classifications. This means there is some disagreement over the status of some countries, but there are some countries that all agree are emerging markets.

‘Emerging 7’

A good starting point would be the E7, otherwise known as the Emerging 7, which was a term coined by economists at PricewaterhouseCoopers in 2006. This groups together the seven largest emerging markets in the world, which are outlined below and ordered by size. The top four are also referred to as BRIC countries. The E7 have been at the forefront of global growth in recent decades. The E7 was about half the size of the G7 in 1995, according to PwC, but roughly matched the group in size by 2015. Estimates suggest that the E7 could be twice as large as the G7 by 2040.

_{(Source: IMF, 2019 forecasts)}

The theory is that growth in emerging markets outpaces that of advanced ones to eventually close the economic gap between the two in terms of GDP and income per capita. PwC forecasts the E7 will experience annual average growth of around 3.5% between 2016 and 2050, well ahead of the G7’s forecasted growth of 1.6%.

The MSCI Emerging Market Index

The Morgan Stanley Capital International Emerging Market Index is one of the most widely-cited indices when discussing emerging markets. Having started in 1988 with just 10 countries, the index has grown to include over 25 countries today. Below is an image outlining how the index classifies developed, emerging, frontier and other countries as of June 2019:

_{(Source: MSCI EM Index. * Standalone countries are measured using same criteria but only included in standalone indices. **West African Economic & Monetary Union includes Benin, Burkina Faso, Ivory Coast, Guinea-Bissau, Mali, Niger, Senegal and Togo.)}

Trade the MSCI Emerging Markets Index with IG

You can trade the MSCI Emerging Markets Index with IG. The underlying futures market only trades between 20:00 – 18:00 New York time, but you can trade the index with IG 24 hours a day.

How to invest in emerging markets

For investors, the purpose of emerging markets is to gain exposure to greater risk for greater reward. We have established that emerging markets will grow faster than advanced economies but that this growth will be more volatile and vulnerable. Compared to advanced economies, emerging markets are more likely to start pedalling backwards and could see the reintroduction of political or economic uncertainty.

Take Greece as an example. The country was one of the original countries to form part of the MSCI Emerging Market Index in 1988 but was then removed in 2001 when its debt crisis started to unravel. Greece was reclassified as an emerging market by the index in 2013, demonstrating how the classification of countries can change.

Directly investing in emerging market stocks

Investors have a number of ways to gain exposure to emerging markets. They can directly invest in companies listed on stock exchanges based in emerging markets, like India’s NSE or BSE. However, investors have to spend a lot of time researching the country and stocks to ensure they fully understand what they are doing.

They could also look to invest in UK-listed stocks that operate in emerging markets, like Infrastructure India, which is based in the Isle of Man, listed in the UK and solely invests in Indian infrastructure projects, mostly in energy and transport. This way, investors get the best of both worlds: exposure to emerging markets but through a company that meets the high reporting and transparency standards as a UK-listed business. Or alternatively, they could invest in companies that are based in emerging markets but listed in the UK.

How to trade emerging markets

Most emerging markets are heavily influenced by developments in advanced economies. For example, any drastic movements in the US dollar usually has a large impact on the currencies of emerging markets. With this in mind, there is an opportunity for traders to gain broad exposure to emerging markets to trade around major occasions, like Federal Reserve meetings or geopolitical events.

For example, the ever-changing nature of the US-China trade war, the Fed’s interest rate decisions or any events that change the value of the dollar can be great times to trade emerging markets.

How to trade interest rates

Emerging markets: investing and trading with IG

You can invest or trade emerging market equities or debt using IG. Just follow these easy steps:

1. Choose whether you’re interested in equities, debt or a combination of the two
2. Choose what type of exposure you want to gain: whether that is broad or to a specific country or sector
3. Research which stocks or indices you want to trade
4. Trade using CFDs

Once you’re ready, open an IG Live Account to get started. If you want to try out your strategy risk-free then you can begin with an IG Demo Account.