Risk and reward dynamics in emerging markets
Emerging markets refer to countries that are in the process of rapid industrialisation and economic growth, transitioning from low-income, less-developed economies to more modern, industrial economies.
Key examples of emerging markets include countries like Brazil, Russia, India, China, and South Africa. Investors and businesses are increasingly attracted to these markets for their potential to offer higher returns and access to new customers, even as they navigate the challenges and risks inherent in these rapidly changing environments.
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Emerging markets are often associated with high growth potential. They typically have lower labour costs, an abundance of natural resources, and significant potential for development and industrialisation, enabling them to achieve growth rates surpassing those of developed economies.
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These nations usually have a younger demographic. This youthful population is not only poised to form a larger workforce but also represents a growing consumer base, which is instrumental in driving domestic consumption and, consequently, economic growth.
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Many emerging markets are currently undergoing substantial economic reforms. These reforms encompass a wide range of measures, such as the liberalisation of markets, improvements in legal and financial systems, and substantial investments in infrastructure and education. This confluence of factors makes emerging markets dynamic and potentially rewarding for investors and businesses looking for new opportunities.
Investing in emerging markets involves navigating unique risks. Understanding and effectively managing these risks is crucial for success in these dynamic but potentially unpredictable markets.
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Political risk is a significant concern, as many of these countries experience frequent changes in government, civil unrest, or have weak legal systems, impacting the business environment and investor confidence.
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Emerging market currencies can be highly unpredictable. Factors such as political uncertainty, changes in commodity prices, and global financial market trends can lead to significant currency fluctuations.
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Financial markets in these regions may lack depth and breadth, making it challenging for investors to buy or sell large quantities of assets without significantly affecting the market price.
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Inconsistent and unclear regulatory frameworks can pose risks to investors. Issues like corruption, lack of transparency, and weak enforcement of laws can be prevalent.
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These economies are often more susceptible to boom-and-bust cycles. High growth periods can be followed by sharp economic downturns, making investments riskier.
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Emerging markets are typically more exposed to external shocks, including changes in global trade policies, commodity price swings, and international financial crises.
Risk mitigation strategies in emerging markets
In emerging markets, risk mitigation strategies are key. Staying informed about market trends and regulatory changes is crucial for timely adjustments. These strategies help in balancing the high-reward potential with the inherent risks of emerging markets.
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Geographical diversification: Investing across various emerging markets can help mitigate risks associated with a specific country. For instance, political unrest in one nation might not affect another stable country in a different region.
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Sectoral diversification: Different sectors react differently to economic cycles. While technology and consumer sectors may thrive in a growing economy, utilities and healthcare might be more resilient during downturns. A mix of sectors can balance the risk-reward ratio.
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Asset class diversification: Inclusion of different asset classes like equities, bonds, and real estate from emerging markets can also provide a cushion against volatility. While equities may offer growth, bonds can offer stability and regular income.
Long-term investment horizon
A long-term investment horizon is often advantageous in emerging markets. By adopting a long-term perspective, investors can ride out short-term fluctuations and capitalise on the gradual economic growth and development these markets often experience. Patience and a focus on long-term goals are key in maximising the potential benefits of investing in these dynamic environments.
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Riding-out volatility: Emerging markets are prone to periods of high volatility. A long-term investment approach can help investors ride out these periods of short-term uncertainty and benefit from the long-term growth trajectory.
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Compounding benefits: Long-term investing in growing economies can take advantage of the power of compounding, where returns themselves generate further returns over time.
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Adaptation to market cycles: A long-term perspective allows investors to adjust their strategies in response to different phases of economic and market cycles, potentially enhancing returns and reducing risk.
Investing in emerging markets
Direct Investment
Direct investment involves directly investing in assets such as businesses or real estate within these markets, offering investors a more hands-on approach with potentially higher returns and greater control. Understanding local regulations, tax implications, and cultural nuances is critical in direct investing. It often requires local expertise or partnerships.
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Equity investments: Buying equities in emerging market companies can offer significant growth potential. This requires understanding the local market dynamics, economic trends, and corporate governance standards. It is crucial to assess company fundamentals, sectoral prospects, and the overall political and economic stability of the country.
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Bond investments: Investing in government or corporate bonds from emerging markets can provide higher yields compared to developed markets. However, it requires an assessment of the credit risk, currency risk, and potential political risks that could affect bond repayments.
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Real estate investments: This involves purchasing property or investing in real estate projects. The real estate market in emerging economies can offer high growth potential but also comes with risks like property rights issues, market fluctuations, and regulatory changes.
Indirect investment
Indirect investment allows for exposure to emerging markets through vehicles like managed funds, exchange-traded funds (ETFs), or shares of multinational corporations operating in these regions, providing a way to participate in the potential growth of these economies with typically lower risk and less active management required. Indirect investments provide an easier entry into emerging markets, reducing the barriers of direct investing. They offer diversification, reducing the risk associated with individual securities.
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Managed funds: These funds pool money from multiple investors to invest in a diversified portfolio of equities or bonds in emerging markets. They are managed by professional fund managers who make decisions about asset allocation and equity selection.
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Exchange-Traded Funds (ETFs): ETFs offer a way to invest in a broad index or a specific sector of emerging markets. They are traded like equities and offer the flexibility of intraday trading. ETFs often have lower fees than mutual funds and provide easy diversification.
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American Depository Receipts (ADRs): ADRs represent shares in a foreign company and are traded on US equity exchanges. They offer a simpler way to invest in foreign companies without dealing with foreign exchanges and currency conversions.
JSE-listed emerging market ETFs
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1nvest MSCI EM Asia Index Feeder ETF (ETFEMA): The ETF tracks the performance of the MSCI Emerging Markets Asia Index that includes large and mid-cap representation across countries including China, India, Indonesia, South Korea, Malaysia, the Philippines, Taiwan and Thailand. The top holdings in this ETF are Taiwan Semiconductor Manufacturing Company, Tencent, and Samsung.
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10X All Asia Actively Managed ETF (APACXJ): This ETF offers a basket of professionally selected shares in the Asia Pacific region (excluding Japan) and includes companies from an array of geographies and across the size spectrum. The benchmark of the ETF is the FTSE Asia Pacific (ex-Japan) Index. The largest holdings in this ETF are Indonesian, Korean, and Taiwanese market trackers.
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Satrix MSCI China ETF (STXCHN): The ETF tracks the MSCI China Index which offers large and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listing and covers about 85% of China equity universe. The largest holdings in this ETF are Tencent, Alibaba, and Meituan.
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Satrix MSCI Emerging Markets ESG Enhanced ETF (STXEME): The ETF tracks the value of the MSCI EM ESG Enhanced Focus CTB Index which measures the performance of emerging market companies but screens out controversial business areas and gives greater weighting to companies with higher environmental, social and governance (ESG) scores. The top holdings in this ETF are Taiwan Semiconductor Manufacturing Company, Tencent, and Samsung.
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Satrix MSCI Emerging Markets ETF (STXEMG): The ETF tracks the value of the MSCI Emerging Market IMI Index which measures the performance of the large, mid, and small capitalisation stocks across emerging market countries. The top holdings in this ETF are Taiwan Semiconductor Manufacturing Company, Tencent, and Samsung.
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Satrix MSCI India Feeder ETF (STXNDA): This ETF tracks the MSCI India Net Total Return Index. The index is designed to measure the performance of the large- and mid-cap segments of the Indian market. It covers approximately 85% of the Indian equity universe. The largest holdings in this ETF are Reliance Industries, ICICI Bank and Infosys.
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Sygnia Itrix MSCI Emerging Markets 50 ETF (SYGEMF): This ETF tracks the MSCI Emerging Markets 50 Index comprising of the 50 largest companies across emerging markets. The top holdings in this ETF are Taiwan Semiconductor Manufacturing Company, Tencent, and Samsung.
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Sygnia Itrix S&P New China Sectors ETF (SYGCN): This ETF tracks the S&P New China Sectors Index. The Index is designed to track the performance of China and Hong Kong domiciled companies in consumption and service-oriented industries. The largest companies in this ETF are Tencent, Alibaba and Moutai.
