Since their introduction in the early 2000s, emerging markets have remained a popular investment area. As a result, a number of new funds and tools for investing in emerging markets have been introduced. Emerging markets are a unique investment opportunity because they offer equal parts of risk and reward. While there are huge gains awaiting investors that can identify the right emerging market investment at the right time, the risks involved are sometimes not well understood. Emerging market equity funds offer investors access to countries and regions that are undergoing economic transition. While there are many ways to define emerging markets (EM), the term typically refers to the two dozen countries that are part of the MSCI Emerging Market index.
Emerging markets are an important part of a well-diversified global equity portfolio. However, recent history reminds us that they can be volatile and can perform differently than developed markets. In the first two decades of the 21st century, emerging markets have witnessed rapid economic development, although at different speeds across different regions. While OECD member countries’ economic growth has consistently been below the world average, Emerging Asia has systematically outperformed the economies of other regions since the beginning of the 21st century. However, the health, social and economic crises brought on by the COVID-19 pandemic have plunged all regions into a deep economic contraction
The trade volume generated by emerging markets expanded significantly from 2000 to 2019, led in particular by the growth of China. Emerging markets’ share of global trade volume also increased from 32% around 2000 to 46% in 2019. Following a significant drop in the first half of 2020 coinciding with the outbreak of the pandemic, global merchandise trade is rebounding, with the exception of cross-border services trade.
In recent years, the returns of emerging markets have lagged behind those of developed markets. Over the past 10 years (2010–2019) the MSCI Emerging Markets Index (net div.) had an annualized compound return of 3.7%, compared to 5.3% for the MSCI World ex USA Index (net div.) and 13.6% for the S&P 500 Index. While recent returns have been disappointing, it is not uncommon to see extended periods when emerging markets perform differently than developed markets. For example, just looking back to the prior decade (2000–2009), emerging markets strongly outperformed developed markets, with the MSCI Emerging Markets Index (net div.) posting an annualized compound return of 9.8%, compared to 1.6% for the MSCI World ex USA Index and –0.95% for the S&P 500 Index.
The global economy is forecasted to grow 5.9 percent in 2021 and 4.9 percent in 2022, 0.1 percentage point lower for 2021 than in the July prediction. The downward adjustment for 2021 demonstrate a downgrade for advanced economies—in part due to supply disruptions—and for low-income developing countries, largely due to worsening pandemic dynamics. This is partially offset by stronger near-term prospects among some commodity-exporting emerging market and developing economies. Merchandise trade will continue to support growth in the EMs in the coming months (inventory restocking continues in advanced economies after registering a very low inventory-to-sales ratio in the first half of 2021), but it is set to moderate. World merchandise trade volume is expected to grow 10.8% in 2021, revised up from 8.0% as predicted in March. Trade growth should slow to 4.7% in 2022, up from 4.0% previously. The pandemic-induced relative increase in goods spending is expected to shift back to services as activity in people-sensitive sectors normalize, thus boosting trade in services.
EM foreign exchange valuations are currently cheap, and current account positions are generally positive, by historical standards. EM currencies that typically appreciate when commodity prices and terms of trade improve have not strengthened in the same way as they have in past episodes of rising commodity prices. Emerging market currencies are expected to have a better performance than the developed-market on the back of the global economic recovery. Emerging market currency markets can yield good opportunities but is also more risky. EM foreign exchange valuations are currently cheap, and current account positions are mostly positive, by historical standards. Investors frequently face political risk, more volatility and lower liquidity than traditional developed world foreign exchange market and policy responses had a larger impact on emerging market currency returns. For the past one and half year, investors has faced more challenge with the pandemic adding another dimension and resulting in even higher volatility. This has considerately lowered the risk /reward of being long in emerging market currencies. These currencies has only recently returned to its average of the last four years but remains far from the lows observed pre-pandemic in early 2020. With the emerging world still lagging the developed one in terms of the post-Covid recovery, due to their poor access to vaccines, volatility and the challenging conditions/environments for investors are both likely to continue, at least in the short term. However emerging market currencies would also benefit from the continued weakening of the dollar and the incoming Biden administration, whose spending priorities are likely to widen U.S. fiscal deficits
