Emerging markets represent some of the fastest-growing economies in the world. Countries like China, India, Brazil, and Indonesia are home to billions of consumers and rapidly expanding middle classes. For investors willing to accept higher risk, emerging markets offer growth potential that developed markets often cannot match.
What Are Emerging Markets?
Emerging markets are economies transitioning from developing to developed status. They typically have:
- Higher GDP growth rates than developed economies
- Rapidly expanding middle classes and consumer spending
- Improving but still developing financial markets
- Higher volatility and political/economic uncertainty
- Greater infrastructure investment needs
MSCI Classification: The MSCI Emerging Markets Index includes 24 countries including China, India, Brazil, South Korea, Taiwan, South Africa, Mexico, and Indonesia. It represents about 10% of global market capitalization but over 40% of world population.
Major Emerging Markets
Understanding the key emerging markets helps you make informed investment decisions:
China
The world's second-largest economy and largest emerging market by weight. China offers exposure to massive consumer spending, technology innovation, and manufacturing. Key sectors include technology (Alibaba, Tencent), electric vehicles (BYD, NIO), and financials.
India
The world's fastest-growing major economy with a young, English-speaking population. Strong in IT services, pharmaceuticals, and financial services. Demographics favor long-term growth as the working-age population expands.
Brazil
Latin America's largest economy with abundant natural resources. Major sectors include commodities, agriculture, and financials. Subject to political volatility and currency swings.
Taiwan
Home to Taiwan Semiconductor (TSMC), the world's most important chipmaker. Technically advanced economy with high-quality companies. Geopolitical tensions with China create unique risks.
South Korea
Technically advanced economy sometimes classified as developed. Home to Samsung, Hyundai, and SK Hynix. Strong in technology, manufacturing, and consumer goods.
Why Invest in Emerging Markets?
Several factors make emerging markets attractive:
1. Higher Growth Potential
Emerging economies typically grow GDP 2-3 times faster than developed markets. This economic growth can translate to corporate earnings growth and stock returns.
2. Demographic Advantages
Many emerging markets have younger populations and growing workforces, unlike aging developed economies. More workers and consumers drive economic expansion.
3. Rising Middle Class
Billions of people are entering the middle class in emerging markets, driving consumption of everything from smartphones to financial services to travel.
4. Diversification Benefits
Emerging markets do not always move in sync with US markets, providing portfolio diversification. Different economic drivers and cycles create varying return patterns.
5. Valuation Opportunities
Emerging market stocks sometimes trade at significant discounts to developed market peers, offering value opportunities.
Growth Comparison
Average GDP Growth (Recent Years):
- India: 6-7% annually
- China: 4-5% annually
- Indonesia: 4-5% annually
- United States: 2-3% annually
- Europe: 1-2% annually
This growth differential compounds over time into significant economic expansion.
Risks of Emerging Markets Investing
Higher potential returns come with higher risks:
Political Risk
Government instability, policy changes, and regulatory actions can dramatically impact investments. Nationalization, capital controls, and corruption are real concerns in some markets.
Currency Risk
Emerging market currencies can be highly volatile. Currency depreciation can erase stock gains when converted back to dollars.
Liquidity Risk
Some emerging market stocks trade with lower volume, making it harder to buy or sell without impacting prices. During crises, liquidity can evaporate.
Governance Concerns
Accounting standards, disclosure requirements, and shareholder protections may be weaker than in developed markets. Corporate governance quality varies widely.
Economic Volatility
Emerging economies are more susceptible to commodity price swings, trade disruptions, and financial crises. Growth can reverse suddenly.
Volatility Reality: Emerging market stocks (EEM) have historically shown about 50% higher volatility than US stocks (SPY). Drawdowns of 30-50% are not uncommon during global financial stress.
Ways to Invest in Emerging Markets
Several vehicles provide emerging market exposure:
Broad Emerging Market ETFs
- VWO (Vanguard FTSE Emerging Markets) - Low cost, broad exposure
- EEM (iShares MSCI Emerging Markets) - High liquidity, options available
- IEMG (iShares Core MSCI Emerging Markets) - Low cost alternative to EEM
Country-Specific ETFs
- FXI (iShares China Large-Cap)
- INDA (iShares MSCI India)
- EWZ (iShares MSCI Brazil)
- EWT (iShares MSCI Taiwan)
Individual ADRs
Many emerging market companies have ADRs trading on US exchanges: Alibaba (BABA), Taiwan Semiconductor (TSM), Vale (VALE), Infosys (INFY).
Active Mutual Funds
Some investors prefer active management in emerging markets given the complexity and inefficiencies. Funds from Templeton, Matthews Asia, and Fidelity are popular choices.
China: Opportunity and Complexity
China deserves special attention as the largest emerging market:
Investment Options:
- H-shares: Hong Kong-listed Chinese companies
- A-shares: Shanghai/Shenzhen-listed (accessible through ETFs like MCHI)
- ADRs: US-listed Chinese companies (Alibaba, JD.com, etc.)
Key Considerations:
- Government intervention and regulatory crackdowns can be sudden and severe
- VIE structures (used by many ADRs) create ownership uncertainty
- Geopolitical tensions with the US create delisting and sanctions risks
- State influence over private companies complicates analysis
India: The Long-Term Growth Story
India presents a compelling long-term investment case:
Advantages:
- Young, growing population (median age around 28)
- English-speaking workforce attracts global business
- Democratic government with property rights
- Strong IT services and pharmaceutical sectors
- Rising domestic consumption
Challenges:
- Bureaucracy and corruption concerns
- Infrastructure gaps
- High valuations relative to other emerging markets
- Limited direct ADR options
Building an Emerging Markets Allocation
Consider these factors when determining your allocation:
Suggested Allocations:
- Conservative: 5-10% of equity portfolio
- Moderate: 10-20% of equity portfolio
- Aggressive: 20-30% of equity portfolio
Implementation Approaches:
- Core approach: Use a broad emerging markets ETF for diversified exposure
- Satellite approach: Core EM ETF plus country-specific positions based on views
- Active approach: Rely on active managers to navigate complexity
Sample Emerging Markets Allocation
Conservative ($10,000 EM allocation):
- VWO (Broad EM): $10,000 (100%)
Moderate ($10,000 EM allocation):
- VWO (Broad EM): $7,000 (70%)
- INDA (India): $2,000 (20%)
- Individual ADRs: $1,000 (10%)
Timing and Cycles
Emerging markets can have extended periods of under and outperformance:
- 2003-2007: Massive outperformance driven by China growth and commodity boom
- 2010-2020: General underperformance vs US stocks
- Dollar strength tends to hurt EM: Rising US rates and strong dollar create headwinds
- Commodity cycles matter: Many EM economies are commodity-dependent
Rather than timing these cycles, most investors benefit from consistent allocation and periodic rebalancing.
Due Diligence for Emerging Markets
Extra research is warranted for EM investments:
- Understand the political environment and recent government actions
- Review currency trends and central bank policies
- Assess country-specific risks (China delisting, Brazil politics, etc.)
- Check fund holdings to understand actual exposures
- Consider ESG and governance factors
Track Your Global Investments
Pro Trader Dashboard helps you monitor emerging market holdings alongside your entire portfolio. Track performance and understand your international exposure.
Summary
Emerging markets offer access to the world's fastest-growing economies and billions of consumers entering the middle class. While the growth potential is significant, so are the risks - from political instability to currency volatility to governance concerns. A thoughtful allocation to emerging markets, implemented through diversified ETFs or carefully selected individual investments, can enhance long-term portfolio returns. Understanding the unique characteristics of different emerging markets helps you invest with realistic expectations.
Want to explore specific regions? Read our guides to Asian markets or learn about managing geopolitical risk.