Investing in emerging markets

As Canadian investors navigate the dynamic landscape of global markets, the question of whether to include emerging markets in their portfolios looms large.

Historically, investing in emerging markets has been met with mixed results, often underwhelming compared to more established counterparts. But will this sector continue to underperform? Or is now the opportune time for it to start to shine? Here are some things to consider:

Historical performance

Emerging markets, encompassing economies in Asia, Latin America, Africa, and the Middle East, have historically exhibited high growth potential but also heightened volatility. Investors have approached these markets with caution due to concerns about political instability, currency risks, and varying levels of market maturity.

In the past, emerging markets have faced challenges ranging from economic crises to geopolitical tensions, influencing investor sentiment and performance outcomes. However, recent years have seen a shift in the global economic landscape, prompting a reassessment of the potential for emerging markets to deliver substantial returns (but not without a continued level of elevated risks).

Let’s take a look at the pros and cons of investing in this asset class and some things that you should consider before jumping in.

Current economic landscape

Several factors contribute to the changing dynamics of emerging markets, making them increasingly attractive to investors:

1. Technological advancements—Emerging markets are experiencing rapid technological advancements, fostering innovation and economic growth. As these economies embrace digital transformation, opportunities for investors in sectors such as technology, e-commerce, and fin-tech are on the rise.

2. Demographic dividends—Many emerging markets boast young and growing populations, creating a demographic dividend that can fuel economic expansion. A burgeoning middle class with rising purchasing power presents opportunities for companies tapping into consumer-oriented industries.

3. Infrastructure development—Governments in several emerging markets are prioritizing infrastructure development. Investments in transportation, energy, and communication infrastructure not only drive economic growth but also offer avenues for foreign investors to participate in these projects.

4. Globalization and diversification—The interconnectedness of global markets has increased, making it imperative for investors to diversify portfolios. As emerging markets become more integrated into the global economy, Canadian investors are exploring these markets as a means of diversification.

Risks and challenges

Despite the potential opportunities, investing in emerging markets comes with inherent risks and challenges.

1. Political and regulatory risks—Emerging markets may face political and regulatory uncertainties that can impact investor confidence. Changes in government policies, currency controls, and geopolitical tensions can create volatility in these markets.

2. Currency risk—Currency fluctuations can pose risks for investors in emerging markets. Sudden changes in exchange rates may affect the value of investments denominated in local currencies.

3. Liquidity concerns—Some emerging markets may have less developed financial markets, leading to lower liquidity. This can affect the ease of buying and selling assets and may result in higher transaction costs.

4. Corporate governance—Governance standards in emerging markets can vary, and some companies may lack transparency and adherence to international standards. Investors need to carefully assess corporate governance practices to mitigate risks associated with unethical conduct.

Is now the time to invest?

The decision to invest in emerging markets should be based on a careful assessment of individual risk tolerance, investment goals, and time horizon. While there are compelling reasons to consider allocating a portion of a portfolio to emerging markets, investors should approach this decision with a strategic mindset.

1. Diversification benefits—Including emerging markets in a well-balanced portfolio can enhance diversification. As these markets often have a low correlation with developed markets, their inclusion may contribute to risk reduction.

2. Long-term growth potential—Emerging markets, driven by demographic trends and technological advancements, hold considerable long-term growth potential. Investors with a horizon spanning several years may benefit from the compounding effects of growth in these economies.

3. Cautious pptimism—While the potential for outperformance exists, a cautious approach is advisable. Investors should conduct thorough research, stay informed about geopolitical developments, and consider a diversified approach that encompasses various emerging market regions and sectors.

The question of whether investing in emerging markets will continue to underwhelm or if it is poised to outperform is multifaceted. The evolving economic landscape, driven by technological advancements, demographic shifts, and globalization, presents new opportunities for Canadian investors. However, the risks and challenges associated with these markets require careful consideration.

Investors seeking to explore emerging markets should approach the decision with a balanced perspective, acknowledging the potential rewards while mitigating risks through thorough due diligence and strategic asset allocation.

Consulting with qualified financial planners and staying informed about global economic trends will empower investors to make well-informed decisions in the pursuit of a diversified and resilient investment portfolio.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.