Emerging Markets are those which are developing and are quite promising to scale up in the foreseeable future. The growth rates of emerging markets are incredibly high but the golden law in business follows, with greater gains come greater risks.
These markets are commonly seen in most of the third – world countries including China and India where there is a boom in manufacturing and research after decades of instability and stagnation of growth.
The Risks of Investing in Emerging Markets
Let the investment be in the form of stocks, bonds, real estate or any other kind, the transactions has to happen in the local currency of the emerging market. Emerging markets have largely fluctuating currency and thus, the returns to the investor are always at risk. It may actually turn into losses if the currency dips suddenly.
Emerging markets are difficult to analyze based on historical data. Developed markets have long gathered data about correlation between events and the corresponding returns but that much load and variety of information is not available in the case of emerging markets. So, some portion of the investment is always a ‘blind throw’.
Also, the wealth in emerging markets are much less liquid and the market is imperfect. It involves high broker fees for every transaction and on the whole and poor corporate governance. Also, due to the uncertainty and a relatively underdeveloped banking system in these markets, it is quite difficult to raise money.
So, should you still invest?
No business occurs without risk of losing the money put in it. A lot of success stories have emerged after investing in the upcoming markets. But these investors have followed two fundamental principles. The first one being, knowing what and how the risk is.
Due to political and currency instability, emerging markets are extremely volatile. A high risk taker might invest 7% of his investment fund allocation to international market and the safest buyer would just allocate 3% of that amount. But given the pace at which the GDP growing in China and India especially, there is a high degree of optimism in the horizon that these investments will do well in the long term.
The second rule the investors in emerging market follow is clearly identifying parameters that might drive the investment itself. They conduct a thorough research on monetary policies, corporate rules, and deviations in market, sector analysis and also government’s activeness in growing the direct local market. As a starting point, they compare the performance of the country with respect to a global benchmark and gather insights from it regarding fund allocation and duration of investment.
The bottom line is that, investing in emerging markets might not be a bad idea at all as long as the investor realizes the value of being consistent in growth instead of chasing spurts of income. Strategies must be devised that can handle the risks imposed effectively, just as it does, if it were the case in a developed market.