Investing in Emerging Markets

TL;DR

Investing in emerging markets may not necessarily lead to higher returns, as historical data shows a negative correlation between economic growth and stock market performance. However, there are other reasons to consider investing in this asset class, such as its larger economic footprint, potential diversification benefits, and factor premiums that exist in emerging markets.

Transcript

• The term emerging markets was coined in 1981 by the International Finance Corporation as a marketing term to help make the case for foreign investors investing in developing economies. Today, emerging markets make up roughly 10 to 12% of the global free float market capitalization, representing around 25 countries, including China, Taiwan, India,... Read More

Key Insights

• 🚨 Expected investment returns in emerging markets do not necessarily correlate with economic growth.
• ↩️ Stock market returns in war-torn countries trail behind their economic recoveries due to high rates of equity recapitalization.
• 👣 Emerging markets have a larger economic footprint and offer diversification benefits to portfolios.
• 😘 Emerging markets exhibit a higher expected return due to factors such as incomplete market integration and lower perceived risks by local investors.
• ❎ Emerging markets have historically shown negative skewness, indicating a higher risk of extreme negative returns.
• 🚨 Negative coskewness with the MSCI World portfolio suggests that adding emerging markets to a portfolio increases its overall skewness.
• 🛀 Historical performance data shows that emerging markets have both outperformed and trailed developed markets, indicating the uncertainty of their performance.

Questions & Answers

Q: Are economic growth and investment returns positively related in emerging markets?

No, historical data shows a negative correlation between economic growth and stock market returns in emerging markets. Countries with stronger economic growth tend to have lower stock market returns.

Q: Why do countries with stronger economic growth have lower stock market returns?

One possible explanation is that expectations of growth and earnings are already priced into high-growth economies, resulting in lower returns. Additionally, as new businesses emerge to meet the demands of a growing economy, earnings are spread across a greater number of shares, leading to lower earnings per share growth and stock returns.

Q: Do war-torn countries experience a disparity between economic growth and dividend growth?

Yes, war-torn countries often undergo a high rate of equity recapitalization, requiring new companies to form and existing companies to raise capital for economic recovery. This dilutes the benefits of economic growth for existing shareholders, resulting in a larger gap between economic growth and dividend growth.

Q: What other factors make investing in emerging markets attractive?

Emerging markets have a larger economic footprint, exhibit diversification benefits with respect to the developed market portfolio, and offer potential factor premiums. These factors contribute to high expected returns, although some of these returns come at the cost of negative skewness, which can be challenging for investors.

Summary & Key Takeaways

• Economic growth and investment returns in emerging markets do not have a positive correlation. Historical data suggests that countries with stronger economic growth tend to have lower stock market returns.

• War-torn countries experience a larger gap between economic growth and dividend growth due to the need for high rates of equity recapitalization, diluting the benefits of economic growth for existing shareholders.

• Emerging markets have a larger economic footprint, offer diversification benefits, and have high expected returns. However, these higher returns come with the cost of negative skewness, which can be challenging to recover from.