Study highlights benefits and risks of investing in emerging markets

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Written by Ray Clancy

Friday, 06 August 2010 08:20

Global emerging market funds have achieved much higher increases in values compared with average results from worldwide stocks but there are risks involved such as political instability and economic mismanagement, a study has found.

The Guide to Emerging Market Funds published by independent research company Defaqto highlights the emerging markets sector as offering ‘considerable potential for growth’.

It found that the average increase in value of unit trusts and OEICs in the global emerging market sector from February 2009 to February 2010 was almost 60%, compared to an average of 25% across worldwide stock markets.

‘The expectations of many economic commentators are that emerging markets will, over the longer term, continue to grow more rapidly than developed ones. According to the Investment Management Association, around 2% of all retail funds under management are invested in the global emerging markets sector. If you include emerging market investment in other sectors, this figure is probably nearer 5%,’ said Fraser Donaldson, author of the guide.

‘As developed markets continue to struggle out of the global recession, we expect interest in emerging markets to grow,’ he added.

The emerging markets highlighted include the BRIC economies of Brazil, Russia, China and India, and also Latin America, Central and Eastern Europe and South East Asia. Common selling points for investment into emerging markets include greater investment in infrastructure, enormous potential for growth, large reserves of raw materials and more stable financial systems, however the risks involved in investing in these markets can include bureaucracy, instability and economic mismanagement, the study points out.

‘Emerging markets seem to be recovering from the global recession more quickly than developed countries, with the threat of the double dip receding. However these markets are politically and economically more volatile than their developed counterparts, and investments in them subject to higher levels of risk than investment in more established markets,’ the report says.

‘The expectations of many economic commentators are for emerging markets to continue to grow more rapidly than developed ones, for the foreseeable future, and with developed markets labouring to move fully clear of the recent economic turbulence, it is sensible that advisers should consider emerging market investment for all but the most risk-averse clients in the future,’ it points out.

‘The negative features of emerging market countries can exhibit themselves in explosive fashions, making investment vehicles and asset prices more volatile than those in developed states. Advisers clearly need to be aware of non-financial factors and of any specific additional risks when researching investment in certain regions and countries,’ it adds.

‘This propensity for volatility is a major factor for investors when choosing suitable investment vehicles. Clearly, it is important to fully understand the risks involved, and the specific economic fundamentals of country risk within a portfolio. The research resource required to manage emerging market risk is high, and advisers should look for specialised expertise in selecting fund management companies.’