How should I invest in emerging markets?

How should I invest in emerging markets?
You could invest directly on an emerging market’s stock exchange, but staying local might be your best bet.
Gemma Boothroyd
Published
August 17, 2021
Updated
August 17, 2021

Brazil, Russia, India, China and South Africa - oh my. Although scattered across all corners of the globe, in the world of investing, these countries tend to get lumped together. They’re emerging markets best known as the ‘BRICS’, ever since Jim O’Neill (a Goldman Sachs economist) claimed they’d dominate the global economy by 2050.

So what do they have in common? Aside from all being emerging market members in the BRICS club, not too much.


What’s an emerging market?


An emerging market is a nation in the process of becoming a more developed economy. Because they usually don’t have all too many similarities with one another (asides from being on a path to bigger, better things), funds and indexes lumping them together can gloss over some major differences.  


What’s the best emerging market ETF?


That can make an emerging market ETF riskier than an ETF tracking something more specific, say a commodity like gold. Consider the iShares MSCI EM ETF. Its top 10 holdings span five countries and four sectors. While on one hand, that could bode well for your portfolio’s diversification, on the other, it could expose you to a little too much variety.

iShares MSCI EM ETF Top 10 Holdings

Name Country Weight (%) Sector
Taiwan Semiconductor Manufacturing Taiwan 7.3% Information Technology
Tencent Holdings China 4.2% Communication
Alibaba Group China 4.1% Consumer Discretionary
Samsung Electronics Japan 3.8% Information Technology
Meituan China 1.6% Consumer Discretionary
USD Cash - 1.2% Cash and/or Derivatives
Naspers South Africa 1.1% Consumer Discretionary
China Construction Bank China 1.1% Financials
Housing Development Finance India 1.0% Financials
Infosys China 0.9% Information Technology


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How should I invest in emerging markets?


Cherry-picking is key. 

And you don’t need to look exclusively at companies founded in an emerging market per se. 

Those firms tend to be a lot more vulnerable to volatility in a country’s domestic economy, as they’ll often be set up to serve the people around them. The path to ‘developed nation’ status can involve big swings in population growth and spending power - being on the wrong side of that growth can pull the rug out from under a business fast.

And if the US raises interest rates, those firms can become even riskier bets. When the Fed hikes rates, capital outflows away from emerging markets and back into America tend to ensue. Which is bad news, since these countries are heavily reliant on foreign inflows - most big money investing in emerging economies still comes from their developed cousins.. 

It’s also worrisome for emerging markets with big, burdensome loans. The IMF reported emerging market borrowing doubled between 2013 to 2018. During that period, US interest rates never exceeded 3.0% and are still relatively low. But, if they start to rise some countries could find themselves with a lot more to pay back.

To avoid some of the uncertainty, the best foray into emerging markets may actually be right in front of your nose.


Unilever


And speaking of, you can look no further than the world’s top soap manufacturer.

Unilever, the owner of just about anything from Dove to Marmite, is a major beneficiary of emerging market growth. 

In its latest quarterly report, the firm saw double-digit revenue growth in China and South Asia, while developed markets grew by only 1.5%.

Emerging markets are home to 80% of the world’s population, but the vast majority have very little spending power. 

Unilever’s strategy is to target these shoppers with low-ticket essentials from detergent to deodorant. By selling them in such enormous quantities, it turns a significant profit. 

With over 25m retail partners spanning developing countries, Unilever’s distribution network is unmatched. Any local competitor would be hard-pressed to compete with the vast scale it’s achieved. 

It seems unlikely that competitive advantage is going anywhere anytime soon, especially now with its digitisation push. 

The firm’s rolling out digital inventory platforms to rural merchants which automate restocking while offering microloans to handle the purchases. That means more items on the shelves for merchants, and more items sold for Unilever.

Guinness


Forget Ireland. Next time you hear Guinness, think Nigeria. 

As the second-largest Guinness market in the world, Nigeria stole the crown from Ireland over 10 years ago. 

The Diageo brand first entered Africa in 1827. Although the British Empire brought it there, the beer’s popularity didn’t falter when Nigeria gained UK independence in 1960. Two years later, Lagos became home to the first Guinness brewery outside of the UK.

And it’s been thriving ever since. Operating profit in Africa soared by 69% last year, with Nigeria boasting a 35% increase in net sales.

But even if that momentum slows, Diageo is better equipped than a locally established company to get back on its feet. If lockdowns were to re-emerge, Diageo’s newly created online ordering platform would give it a major leg up on local beer and spirit makers. Which makes it a less vulnerable investment, but one which still bears a high potential for growth.

That’s the main point here: a wise emerging market strategy includes firms well equipped to take advantage of their growth potential, while also holding the capital to handle any pending blows.

You just need to see the forest from the trees, and not get bogged down by building material acronyms (ahem, BRICS) that combine countries and companies together without any real rhyme or reason.


What do you think about the investment case for emerging markets? Let us know on the community forum:


Freetrade Community Forum


Important Information

This should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice.

When you invest, your capital is at risk. The value of your portfolio can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future results.

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