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Beginner's Guide to Emerging Markets

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Emerging markets are back in vogue as ISA and Sipp investors look for money-making opportunities in a low growth world.

by Gavin Lumsden on Feb 22, 2013 at 12:17

Beginner's Guide to Emerging Markets

As a follow-up to my 'Beginner's Guide to China' video I've turned my attention to emerging markets as a whole.

With the much of the developed world stuck in a post-financial crisis slump emerging markets are once again being talked about as the best source of long-term investment opportunities.

But what are emerging markets? And how risky are they?

This is the latest video in The Lolly Investor Programme series. You can see the previous videos on the Lolly Investor Programme page.

Can't watch now? You can read the script below.

The question anyone thinking about their ISA and pension asks is: where is the best place to grow your money?

With interest rates stuck at all-time lows and inflation eroding the value of your money the answer is to invest in the stock market for the long term.

Long term because stock markets have a habit of lurching up and down so to stand a chance of getting the best return you have to invest for at least 10 years or more. 

The trouble is the long-term prospects for the UK and many developed nations look pretty cloudy at the moment.

The huge debts piled up by Western governments before and during the financial crisis will depress their economies for years to come.

Investing in the UK is not impossible but an increasing number of investors are looking at the so-called ‘emerging markets’ for what they see as better growth opportunities.

But what are ‘emerging markets’? And are they a good place to invest?

Emerging markets is the broad term used to refer to a wide range of countries in Asia, Latin America, eastern Europe and Africa whose economies are to varying degrees catching up with the West.

It’s wrong to think of emerging markets as one bloc. They are a diverse group of nations with their own histories, cultures and specific challenges and opportunities.

Nevertheless, many emerging markets share the following characteristics:
• An abundance  of natural resources 
• But with much lower incomes than we have in the West
• Young and rapidly growing populations
• And a lack of social security that makes their people keen to work hard
• Governments that as a result do not have big debts
• And are therefore prepared to spend money on infrastructure to improve the lives of their people and modernise their economies
• And all of this is happening amidst a huge urbanisation trend as people move from the country into towns.

Of course emerging markets are not without their problems. Many suffer poverty, inequality and corruption. The presence of authoritarian regimes mean in many the concepts of legal and property rights can make investing in them hazardous.

Emerging markets are definitely high risk.

Our 10-year chart shows emerging markets swing up and down even more than the UK stock market or the global stock market as a whole.

When developed markets are rising, emerging markets tend to do even better. Look at the 40% gain in 2003 and 59% surge in 2009!

But when markets fall, emerging markets fall furthest, crashing 35% in 2008 and 17% in 2011.

This volatility is largely caused by the herd-like behaviour of overseas investors – who pile in and out very quickly.

For the longer-term investor who can stomach the ride, though, the rewards can be huge. In the 10 years to the end of 2012 the MSCI Emerging Markets index, which is what we’re looking at, grew by over 400%!

Global stock markets returned just 162% with the UK’s FTSE All Share doing a bit better with 170%.

It’s important not to get too carried away with these figures.

The five-year returns from emerging markets are a lot less impressive because of the financial crisis.

Going forward, emerging markets are probably better placed to grow faster than Western developed economies.

However, emerging markets operate in a global economy. Their growth is likely to be more subdued as a result of the sluggish economies in the West.

How do you invest in emerging markets? As always investors have a few choices.

You can put your money into a fund tracking an index like the MSCI Emerging Markets. Long-term returns from emerging market trackers are very good, but they will follow the market passively up and down, through bad and good.

Alternatively, you can invest in an actively managed fund that seeks to buy shares in the best emerging market companies.

Long term most active funds don’t beat  the returns you can get from an emerging markets tracker, but there are a few that have done much better, falling less than the market in a crash and rising more in a recovery.

Do your research and find out which they are although bear in mind that past performance is not much of a guide to the future.

And don’t forget bonds or the IOUs countries and companies issue when borrowing money from investors.

Bonds pay a fixed rate of interest and don’t tend to grow as fast as shares, although they have done very well in recent years.

The bonds market is under a cloud at the moment as rising interest rates and inflation threaten to hurt future returns. That said, bonds from emerging market countries could do better in the long term as their economies grow. There are emerging market bond funds that specialise in this area so have a look at them too.

I’ll finish by reminding you that you can tap into the emerging markets theme by investing in UK funds and companies. For example, the top holding in one leading global emerging markets fund is Unilever, the consumer goods giant based in the UK that has operations in most emerging markets.

Investing begins at home even when it’s the emerging markets.

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