What are emerging markets?

Emerging markets are nations that are investing in more productive capacity. They are moving away from their traditional economies that have relied on agriculture and the export of raw materials. Leaders of developing countries want to create a better quality of life for their people. They are rapidly industrializing and adopting a free market or mixed economy.

A few examples of emerging markets are Brazil, China, India, and Russia. There are five defining characteristics of an emerging market, namely low income, rapid growth, high volatility, currency swings and high potential returns.

Low income drives rapid growth

The first defining characteristic of emerging markets is that they have lower-than-average per capita income. Low income is the first important criterion because this provides an incentive for the second characteristic, which is rapid growth.

Leaders of emerging markets are willing to undertake the rapid change to a more industrialized economy to remain in power and to help their people.

The World Bank is moving away from defining "developing" countries, and instead groups countries by income levels.

Low-income and lower-middle-income countries have an annual per capita income of $4,095 or less.

High-income economies have a per capita income of $12,696.

In 2021, the economic growth of major advanced economies, such as the United States, Germany, and the United Kingdom, was 5.4%.

Growth in emerging and developing countries in Asia, such as China, saw their economies grow by more than 8%.

Rapid change leads to high volatility

Rapid social change leads to the third characteristic of emerging markets, which is high volatility.

That can come from three factors: natural disasters, external price shocks, and domestic policy instability.

Traditional economies traditionally reliant on agriculture are especially vulnerable to disasters, such as earthquakes in Haiti, tsunamis in Thailand, or droughts in Sudan.

But these disasters can lay the groundwork for additional commercial development, as it did in Thailand.

Emerging markets are more susceptible to volatile currency swings, such as those involving the U.S. dollar. They are also vulnerable to commodities swings, such as those of oil or food. That's because they don't have enough power to influence these movements.

For example, when the United States subsidized corn ethanol production in 2008, it caused oil and food prices to skyrocket. That caused food riots in many emerging market countries.

When leaders of emerging markets undertake the changes needed for industrialization, many population sectors suffer, such as farmers who lose their land.

Over time, this could lead to social unrest, rebellion, and regime change. Investors could lose all if industries become nationalized or the government defaults on its debt.

Growth can lead to high returns

This growth requires a lot of investment capital. However, the capital markets are less mature in these countries than what is seen in developed markets. That's the fourth characteristic: currency swings.

Emerging markets don't have a solid track record of foreign direct investment. It's often difficult to get information on companies listed on their stock markets.

It may not be easy to sell debt, such as corporate bonds, on the secondary market. All these components raise the risk. That also means there's a greater reward for investors willing to do the ground-level research.

If successful, rapid growth can also lead to the fifth characteristic, which is the higher-than-average return for investors.

The companies that fuel this growth will realize a profit. This interaction translates into higher stock prices for investors.

It also means a higher return on bonds, which cost more to cover the additional risk of emerging market companies.

What it means to individual investors

There are many ways to take advantage of high growth rates and opportunities in emerging markets. The best is to pick an emerging market fund.

Many funds either follow or try to outperform the MSCI Index. That saves you time. You don't have to research foreign companies and economic policies.

It also reduces risk by diversifying your investments into a basket of emerging markets, instead of just one.

Source: The Balance Money