Do emerging markets represent an opportunity to fast-track your investments? Back in the early Noughties, emerging markets were the place to be for the adventurous investor in search of a good return.
Double-digit returns were clocked up in some countries as the developing world’s burgeoning middle class sought to catch up with peers in the West.
Meanwhile Western consumers were greedily gobbling up all the cheap consumer exports the emerging markets could produce.
The came the financial crisis, and while Western stockmarkets tanked, emerging market stocks fell off a cliff.
Fast forward to 2015, and emerging markets had recovered well, albeit with much greater volatility, largely linked to concerns over the sustainability of China’s rapid economic growth.
Then in January 2016 a perfect storm hit the markets – a serious slowdown in China, a slump in oil prices and a rise in US interest rates. Investors pulled cash out of emerging markets like the proverbial rats leaving a sinking ship.
Except the ship didn’t sink – by March last year, emerging market stocks had recovered well, and investors have been piling back in again in a big way.
Emerging markets and developing economies now account for more than 75% of global growth in output and consumption, according to the International Monetary Fund (IMF) – almost double the amount 20 years ago.
Economic growth in the developed world is predicted to rise to 2% by 2018, but in emerging markets is expected to reach 4.5%.
Be prepared for volatility
So what can we learn from the past 15 years? Do emerging markets represent a safe investment – and can you afford to miss out on the current boom?
According to Laith Khalaf, senior analyst at Hargreaves Lansdown, it depends on your investment horizon – but if you do, be prepared for volatility.
“If you are a long-term investor then absolutely invest in emerging markets, as long as you have the capacity to watch your capital fall – because that will happen at some stage,” he says.
“Whether it’s next month or three years from now, you can make a fair prediction there are going to be some pretty nasty falls in the market over the next 10 to 20 years – and there will be some pretty nice rises, as well.
“It’s an area where there is a developing infrastructure and in a lot of places a growing middle class as well who are looking to consume all the kinds of goods we are used to in the developed world, and that helps to drive company profits.
Emerging market countries are difficult to ignore
“It’s a more volatile area, but it’s an area where if you are a long-term investor it’s difficult to ignore.”
Khalaf says a young person choosing funds for their pension should automatically include some exposure to emerging markets, unless they were particularly risk averse.
“If you are someone in their 20s or 30s and you’re investing your pension that you’re not going to get hold of for 30-plus years, you might want to have a bigger slug of emerging markets in there,” he says.
“If you have a long time-frame and you are investing in a pension, that’s going to smooth out a lot of the volatility you see in those markets, and you also have the time to stick around and ride out those painful periods in search of the higher long-term returns you would expect for taking more risk.”
He adds that given the volatility, it’s a good idea to spread the risk by investing in funds that cover a number of emerging markets, rather than focusing it all on one single economy.
So who are the current rising stars in the emerging markets universe – and who has fallen out of favour?
Brazil, once the darling of EM investors, is languishing in the doldrums following a raft of corruption scandals at both corporate and political level.
One of the country’s biggest companies, Petrobras, has been mired in a scandal over claims that up to $10bn was siphoned off to pay for political campaigning by former President Dilma Rousseff while she was chair of the company’s board.
Rousseff herself was impeached in August 2016 for breaking budgetary laws after serving five years as president.
Hopes of former left-wing president Luiz Lula running again in 2018 were dashed after he was jailed in July 2017 for taking bribes and money laundering.
If the current, interim president Michel Temer – seen as market-friendly – can hold on in next year’s elections, that might signal an upturn. But he is also facing bribery allegations – and possibly even impeachment – and his approval ratings are poor.
Whoever takes over has a big hill to climb in terms of regulatory and economic reforms to revitalise this member of the once vaunted BRIC economies (Brazil, Russia, India, China).
“The chickens have come home to roost here,” says Khalaf. “Two of the key risks for an investor are political risk and fraud risk, and we have obviously seen corruption both at the political and corporate level come to the fore in Brazil.”
He adds: “That’s part and parcel of the risk of investing in these areas – that’s why it’s important if you are an investor it’s best not to go out and just pick one or two markets to invest in, it’s best to pick a generalist fund where you’re going to get a lot of diversification across a number of regions. That way if there is flare-up in Brazil or wherever, you’re not overly exposed.”
Russian is seeing the first shoots of growth after nearly two years of recession caused by low oil prices and economic sanctions after its invasion of the Crimea.
A slight recovery in oil prices, following its agreement with OPEC nations to control output, together with higher commodity prices, have helped to steady the ship. The Russian economy has shown signs of being able to ease itself off its dependence on oil and gas, while inflation has slowed and wage growth resumed.
“Over recent years, Russia has accomplished many positive changes across multiple areas of business regulation, helping improve its investment climate,” says Andras Horvai, World Bank country director for the Russian Federation.
“Removing structural constraints that would lead to increased productivity and addressing the complex socio-economic issues of an ageing society would help even more in attaining higher and sustainable economic growth.”
Many experts view India as the next China in terms of its potential for dramatic economic growth.
Market reforms introduced by popular prime-minister Narendra Modi, who took office in 2014, are modernising the country’s ponderous bureaucracy and centralising power in the national government.
The Goods and Services Tax (GST), which came into effect on 1 July 2017, is the biggest reform of the tax system since independence from the UK. GST aims to replace a plethora of around 17 different state and national taxes, and make it easier for companies to trade within India.
Other business-friendly reforms have been introduced such as making it easier for firms to hire and fire staff, while corporate taxes have also been cut.