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Cheat Sheet

Emerging Markets For Dummies

From Emerging Markets For Dummies by Ann C. Logue

In today's global economy, investors are looking more and more toward investment opportunities in emerging-market nations around the world in order to grow their portfolios. Understanding currency movements, teasing out corporate governance issues, choosing among mutual funds, exchange-traded funds (ETFs), and other investments, and considering what you can do to support further economic development are essential for your success when investing in emerging markets.

Emerging Markets: What Makes Exchange Rates Move

Changes in the value of currency affect the value of your overall investment in emerging markets. The prices go up and down, appreciate and depreciate, but what's good and what's bad? It all depends. Here are some guidelines to help you figure out what's happening when exchange rates move. Keep in mind that some effects may be stronger than others.

  • If interest rates go up, then foreign investors will want to invest, and the currency will increase in value.

  • If inflation goes up, then consumers will look for cheaper imported goods, and the currency will decrease in value.

  • If the risk in a country increases, then investors will want to put their money in less risky places, and the currency will decrease in value.

  • If a country produces popular goods for export, then customers in other countries will need money to buy the products, and the currency will increase in value.

  • If a country imports more goods, then people in the country will need to buy foreign currency to pay for them, and the currency will decrease in value.

Corporate Governance Pitfalls in Emerging Markets

When you invest in another country, the laws of your home country don't apply. The accounting systems may be different, and it may seem as though all the company executives are related to one another. When investing in emerging markets, here are a few of the differences to watch for:

  • Different accounting standards: In many emerging markets, the financial statements aren't detailed. Companies may be allowed to use reserves to manage income, and they may be allowed to book revenues before they're certain that they'll receive them.

  • Nepotism: In some places, hiring relatives is viewed as a good thing because they're known to other employees and are loyal to the business. In other places, the practice is considered to be bad because you end up with mopes who can't get jobs elsewhere and who can't be fired for incompetence. You're likely to run into a lot of nepotism in emerging markets, and it isn't always good.

  • Family ownership and control: Many companies in emerging markets were started and are controlled by prominent families. They may control the board of directors and have most of the votes on shareholder issues. In these situations, the family's concerns are always more important than those of other shareholders.

  • Cross-ownership: In many countries, public companies are owned in part by the shareholders and in part by other public companies. This arrangement can make business complicated; as with family ownership, the concerns of the smaller shareholders aren't considered.

  • Corruption: Corruption is common in some emerging markets, often because the government and other institutions haven't always worked, and people have had to find ways to work around them. Corruption can interfere with free markets and add to expenses, making business more difficult.

Putting Your Foreign Investment in ETFs versus Mutual Funds

Exchange-traded funds (ETFs) and mutual funds are popular ways for people to invest in emerging markets because they offer diversification and professional management. The two have some differences between them, though, such as:

  • Mutual funds are usually actively managed, with the portfolio managers buying and selling securities as they find better opportunities. ETFs are usually managed against an index, with the fund managers buying the securities in the index in the same proportion.

  • You can often purchase mutual funds directly from a fund company. You purchase ETFs through a brokerage account.

  • Some mutual funds have very high fees. Fees on ETFs tend to be low.

  • Mutual funds are designed for long-term investors. ETFs are a better choice for investors who want to be active traders.

Emerging Markets: Harnessing the Power of Social Activism

In many emerging markets, economic development often is held back by a government where the officials enrich themselves rather than help their citizens. Investors' power can bring change in such emerging markets — changes that can counteract moves that prevent economic development.

One of the simplest tools of social activism is a boycott, in which you refuse to buy certain types of products that may be financing bad behavior: diamonds used to finance unnecessary wars; clothing made under sweatshop conditions; oil extracted without any regard for the environment. If these boycotts are well-organized so that they catch on with people, they can be effective in using market power to bring change.

Another trick up an investor’s sleeve is the use of shareholder resolutions and proxy voting to help convince multinational corporations to act responsibly no matter where they operate. These resolutions have been used to address environmental and working conditions in places where the laws are lax. Basic instructions for filing a shareholder resolution can be found on the AFL-CIO Web site.

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