Should you invest in emerging markets?

The term “emerging markets” (EMs) was coined almost four decades ago to embrace middle-income developing countries in transition to developed status. In the early 1990s, a further category was identified – “frontier markets” (FMs) – to describe markets too small, risky or illiquid to make it into the EM category.

Emerging markets are far too important for investors to ignore. Today’s EMs and FMs make up 55% of the world’s Gross Domestic Product (GDP) at purchasing power parity, as compared with 37% for developed markets (DMs). The remaining 28% of the world’s population live in countries with tiny equity markets or no such markets at all.

As we detail in the 2019 Global Investment Returns Yearbook (an in-depth study that we produce annually in collaboration with Credit Suisse), over a period of almost 40 years, EM nations have almost doubled their share of world economic output (measured in purchasing power parity terms) from a quarter to almost half. Meanwhile, the proportion accounted for by DMs has fallen from just over 60% to 37%.

The relative importance of emerging vs developed economies is far from fully reflected in the size of their equity markets available to global investors. This is for a variety of reasons. In some EMs, local shares are inaccessible to overseas investors. In many EMs, the average “free float” – the proportion of a company’s shares available to buy and sell – is far lower than in DMs.

Nevertheless, even taking these factors into account, emerging and frontier markets have grown to a significant size: their combined weighting in global equity indices is now around 12% compared with a negligible 2% in 1980.

Strikingly, that growth took place in the years up to 2007: since then, the combined EM and FM share of the global whole has stagnated. Why? Mainly because the remarkably strong performance of US equities in subsequent years has outpaced the growth in EM markets: the US now accounts for more than half the value of equities worldwide.

Individual EMs have provided widely differing returns to global investors. So within the EM universe, which countries have done best? China is the most common focus of attention. That is hardly surprising. By the end of 2018, it accounted for more than 30% of the value of EMs as a whole, followed by Korea, Taiwan, India and Brazil.

Making very long-term comparisons is a process fraught with difficulties. In Russia, for example, investors lost everything following the 1917 revolution. The same was true of China when markets were closed in 1949 following the communist victory.