Investing in Emerging Markets: Factors to Consider when Making Your Portfolio Decision
Investing in emerging markets can be a great way to add diversity and growth potential to your portfolio. But, these markets come with their own set of risks that you should be aware of.
Emerging markets can grow quickly, offering higher growth potential compared to developed economies. For instance, between April 2003 to December 2007, the iShares MSCI Emerging Markets ETF (EEM) grew by 338%, averaging roughly 96% annually. However, these growth periods are not always smooth and easy. The ETF has demonstrated dips as drastic as its gains.
Diversification is another advantage of investing in emerging markets. By investing in these economies, you can hedge against domestic market volatility since the behaviors of emerging markets may not be directly related to those of developed economies. Furthermore, emerging market stocks can often be better values than their developed counterparts, with lower P/E and P/B ratios, making them an attractive option for value-seeking investors.
However, emerging markets also come with risks. They are more volatile due to factors like currency risk and political instability. Currency movements can affect returns, and political uncertainty can destabilize the business environment and reduce earnings. So, while emerging markets offer growth potential and diversification benefits, they are not for the risk-averse investor.
The ideal role of emerging markets in a diversified portfolio is complementary, serving as a strategic addition rather than a core holding. Experts recommend allocating 2-9% of a portfolio to emerging markets, depending on risk tolerance and investment timeline. You can start with a small allocation and gradually increase it as you become more comfortable with these assets.
To decide if emerging markets are right for you, consider whether your current portfolio is meeting your expectations and whether you can accept volatility for the diversification benefits. There are three common ways to invest in emerging markets: global funds, dedicated ETFs, and American Depository Receipts (ADRs).
Here are three ways to fulfill your emerging market allocation:
- Global Funds: Some global funds include emerging markets exposure alongside securities from developed countries. An example is Vanguard FTSE All-World ex-US ETF (VEU), which has more than 3,800 non-U.S. stocks from around the world, with emerging markets representing 26.4% of the portfolio.
- Emerging Market Funds: You can invest in a dedicated emerging markets fund, such as iShares MSCI Emerging Markets ETF (EEM), which holds over 800 emerging markets stocks, or Vanguard Emerging Markets Bond Fund Investor Shares (VEMBX), which focuses on government bonds from various EMs.
- Individual Stocks: If you prefer individual positions, you can seek out emerging market stocks trading on U.S. exchanges, such as chip foundry Taiwan Semiconductor (TSM), Chinese tech company Alibaba (BABA), or e-commerce firm PDD Holdings (PDD).
In summary, emerging markets offer attractive growth potential, diversification benefits, and attractive valuations. However, they are also more volatile due to currency risk and political risk. Experts recommend a strategic allocation of 2-9% of a portfolio to emerging markets, depending on risk tolerance and investment timeline. As always, consult with a financial advisor before making any investment decisions.
Emerging market currencies can significantly influence returns in these investments, taking the average back to varied levels. For example, a2c396e244d06cef6d29c0d741821905, an ETF tracking emerging market currencies, has exhibited both high growth periods and steep declines.
Investing in this ETF, and other emerging market assets, can help you achieve average growth rates that differ from developed economies, adding a layer of diversity to your portfolio's averages.
