High-growth potential is the number one reason investors look to emerging markets for a portfolio boost. That’s because emerging markets are where most of the world’s economic growth is happening these days, so investing a portion of your portfolio in these growing economies may give you higher return potential. However, it’s important to note that this investment approach can be affected by different factors—and understanding these relationships may help you as you begin investing in emerging markets.
Defining Emerging Markets
Emerging markets are progressing economies that have not yet reached the level of a developed economy. China, Mexico, Brazil and Turkey are all examples of emerging markets countries. Emerging markets typically have:
- Rapid growth and industrialization.
- Favorable demographics and younger populations than developed markets
- Market liquidity that is increasing (the ability to quickly buy and sell assets)
A form of emerging markets is frontier markets, which are at an even earlier developmental stage. Argentina, Kenya, Romania and Vietnam are examples. Frontier markets are:
- Home to one-fifth of the world’s population, but account for just two percent of world’s market capitalization.
- Less developed, which can mean heightened risks from liquidity, political instability, insufficient regulation and currency fluctuations.
Influential, Yet Often Ignored
Emerging markets have a significant impact on the global economy. The favorable demographics shown in the illustration below—a younger population, growing GDP and projected middle class growth—all likely point to investment opportunities. Yet many investors don’t include them in their portfolios; in fact, emerging markets equities represent 2.5 percent of U.S. investor portfolios, while emerging markets debt represents just 0.39 percent.1
Critical Influences on Emerging Markets
Understanding emerging market drivers can help familiarize you with how this type of investment might react to economic factors. Drivers listed below also affect developed markets, but their effects can be magnified in emerging markets because of their complexities and inefficiencies.
1. GDP growth
Gross domestic product (GDP) measures progress and indicates the general direction of a country’s overall economy. GDP growth potential in emerging markets is currently more than two percent higher2 than developed markets, which may help compensate investors for increased risks.
2. Commodity prices
A barometer for global activity, commodity prices affect importing and exporting countries differently. For importers, rising prices translate to higher manufacturing costs and goods prices. By contrast, rising prices mean higher revenues and, potentially, growing GDP for exporters. The reverse is true for falling prices.
3. U.S. monetary policy
The Federal Reserve’s primary tool for monetary policy is interest rate adjustments, which can affect emerging markets. For example, rising U.S. rates could attract foreign investment and cause the dollar to appreciate. This, in turn, would increase debt servicing costs for emerging markets and depress currency values.
4. Local inflation/deflation
Low, consistent inflation is generally considered best for any economy, but extremes in either direction can be detrimental. High inflation can negatively impact currency value and the foreign exchange rate, driving more inflation and rising interest rates. Prolonged falling prices, or deflation, can cut corporate profits, which could fuel workforce reductions and lower consumer demand.
5. Currency appreciation
Government policies, interest rates, trade balances and business cycles can all affect a currency’s value. Increased values are generally positive for the importing country because goods are cheaper to buy. However, for an exporting country, higher currency values mean goods are more expensive for other countries to purchase.
6. Current account balance
Representing the difference between a nation’s savings and its capital investment, a country’s current account balance can help determine how its economy fares. A surplus enables a country to lend to other parts of the world, finance future growth and boost local employment. A deficit can put a country in the borrower seat, which could result in lower foreign investor confidence and potential currency deflation.
7. Country risk
Political and economic unrest can significantly impact a local market’s stocks and bonds. For emerging markets, this can create volatility, causing investors to demand higher returns (because they are taking more risks), and make borrowing more expensive. It can also deter foreign investment, stunt economic growth and create an unpredictable business environment.
8. Regulatory environment
A country’s regulatory environment may include requirements for business registration, product approvals, environmental restrictions, and more, and they can result in significant costs for businesses in emerging economies. This is especially true if rules are applied inconsistently, there are complex differences from market to market, and if the landscape shifts with little notice.
Monitoring these factors for each emerging market country and businesses takes time and experience, especially for managing risks that come with changing tides. These are reasons we advocate an active approach when considering emerging markets.
Emerging Markets May Be Worth a Look
Expectations for growth potential in emerging markets is still moderately high, even with periods of volatility. Understanding why this growth may be possible and the economic drivers of emerging markets may help you decide if they will fit in your portfolio.
Learn More About Investing in Emerging Markets
Check out the latest video from Patricia Ribeiro, vice president and senior portfolio manager, as she provides her outlook for emerging markets.
1Data from 12/31/1990 to 12/31/2021. Data beyond 2015 is estimated. Source: FactSet, IMF World Economic Outlook, 2015.
2 Source: Morningstar, Inc., as of 3/31/2017
International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of Sibil Sebastian and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice.