What are emerging markets?
By definition, emerging markets are developing economies, many of which are experiencing rapid growth and industrialization. An emerging market is a country that has some characteristics of a developed market, but isn’t a developed market yet. These countries possess securities markets that are progressing toward, but haven’t reached, the standards of developed nations.
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Which countries fall under this category?
Companies considered to be trading in the emerging market are usually located in less economically developed countries (or LEDCs). The category includes countries that may be developed markets in the future or were in the past. The four largest emerging and developing economies are the BRIC countries—Brazil, Russia, India, and China. The next four largest markets are MIKT— Mexico, Indonesia, South Korea, and Turkey. However, South Korea isn’t considered an emerging market by some sources. Iran is also considered an emerging market.
Investing in emerging markets
While those with a smaller risk appetite tend to invest more in blue chip stocks like Apple (or AAPL) and Microsoft (MSFT), investors willing to take on additional risk to reap high returns turn to emerging and frontier markets.
Emerging markets are sought by investors for the prospect of high returns, as they often experience faster economic growth as measured by gross domestic product (or GDP). Emerging economies are expected to grow two to three times faster than developed nations like the U.S., according to International Monetary Fund (or IMF) estimates. Also, according to IMF estimates, around 70% of world growth over the next few years will come from emerging markets, with China and India accounting for 40% of that growth.
However, investments in emerging markets come with much greater risk due to political instability, domestic infrastructure problems, currency volatility, and limited equity opportunities. Also, the local stock exchanges may not offer liquid markets for outside investors.
Popular exchange-traded funds (or ETFs) investing in these emerging markets include the Vanguard FTSE Emerging Markets ETF (VWO) and the iShares MSCI Emerging Markets Index Fund (EEM). Both these ETFs have invested heavily in financial services and technology stocks of emerging Asia, including China and India, and Latin America, specifically Brazil. Major holdings include companies like Tencent Holdings Ltd. (TCEHY) and China Mobile Ltd. (CHL). While the VWO is invested up to 80% in emerging economies, the EEM has a 65% emerging market exposure. Both have their country-wise leading holding in China—19% and 17%, respectively.
Let’s move on to understand the frontier markets, and how they’re different from emerging markets.