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Managing Risks if You Invest in Emerging Markets

Sure, investing in emerging markets isn't without risk, but that shouldn't dissuade you from doing it. These growing economies are great places to look for wonderful investment opportunities — as long as you to take necessary precautions. By managing the risks associated with emerging markets, you can make the most of the opportunities that are presented to you.

Do your homework

Doing careful research can help you better identify your sources of risk and return, which in turn can help you better understand when — and how much — to buy and sell. Doing your homework starts with a good understanding of the country and the industry that you're investing in.

When you start your research into the country and industry, ask some basic questions: Who runs the government? Is the government committed to development? Who competes for customers and funds with the investment that you're considering?

Because markets change quickly, especially new markets, be sure to rely on news sources for up-to-date information. Two great places to start are The Economist magazine and the Wall Street Journal. The Economist is published in London and offers great weekly coverage of business and political issues all over the world. The Wall Street Journal covers business and investing issues worldwide and has some of the best coverage of Asia around.

The next step is looking at the financials of the investment that you're considering. How will it make money? How much funding will it need to grow?

Finally, keep in mind that research is an ongoing process. You need to keep it up to see whether situations have changed. Maybe you want to commit more money to a market or investment, or maybe you want to cut back. The more you know, the better decisions you can make.

Considering a nation's membership in economic organizations

The Organisation for Economic Co-operation and Development (OECD) represents the nations that are commonly thought of as developed. The OECD is great for researchers because it collects so much data on economic affairs. Some organizations related to the OECD are the G-7, which stands for the Group of 7 and includes the countries with the world's largest economies; the G-8, which is the G-7 plus Russia; and the G-20, which includes 19 nations and the European Union. These organizations work to promote international financial stability more than international development, and OECD members collect and share information about their economies in order to develop new policies for themselves and to assist in the development of the rest of the world.

The following table contains a list of nations and the organizations each belongs to. The categories can help you think about where to invest.

Much of your success in investing in emerging markets comes from identifying the countries that are growing now and that are likely to continue to grow in the future. Even a mediocre company can grow as it sits in a growing country, but a great company can be held back in a mediocre country. As you look at this list, think about what would it take for a country to move up or down a category? How likely is such a change? What would happen to your investments if such a change took place?

Nation OECD MSCI Emerging Markets Index G-7 G-8 G-20
Argentina x
Australia x x
Austria x
Belgium x
Brazil x x
Bulgaria
Canada x x x x
Chile x x
China x x
Colombia x
Cyprus
Czech Republic x x
Denmark x
Egypt x
Estonia x
Finland x
France x x x x
Germany x x x x
Greece x
Hungary x x
Iceland x
India x x
Indonesia x x
Ireland x
Israel x
Italy x x x x
Japan x x x x
Latvia
Lithuania
Luxembourg x
Malta
Malaysia x
Mexico x x x
Morocco x
Netherlands x
New Zealand x
Norway x
Peru x
Philippines x
Poland x x
Portugal x
Romania
Russia x x x
Saudi Arabia x
Slovak Republic x
Slovenia x
South Africa x x
South Korea x x x
Spain x
Sweden x
Switzerland x
Taiwan x
Thailand x
Turkey x x x
United Kingdom x x x x
United States x x x x

The borders between developed and emerging markets blur, and nations often move between them. Iceland, for example, is an OECD nation that had a strong, developed economy at the end of the 20th century and into the 21st. Several of its major banks collapsed in 2008, taking down its currency and its economic prospects and, for practical purposes, moving it back to emerging markets or even frontier status, at least as of this writing. If you can identify a market that's likely to be promoted, you may find a great market to invest in.

Using intermediaries or advisors

The emerging markets you're interested in may be far from where you live and show up in the news less often or not at all. This lack of exposure can make research difficult and put you at a disadvantage. To get around this situation, consider using an intermediary. The most popular intermediaries are emerging market mutual funds and exchange-traded funds (ETFs) that pool money from many different investors. The fund managers concentrate on emerging markets and have access to research and travel budgets that you may not have. Their job is to find investment opportunities and assess risks so that their clients can make money, so they can devote more time and effort than you may be able to on your own.

If you have a great deal of money to invest, you can work with a private investment fund or a wealth manager with a specialty in emerging markets. A private investment fund is similar to a mutual fund in that it pools money from many different investors, but it may have more flexibility. In exchange, you need to commit a great deal of money.

Some brokers, wealth mangers, and other financial advisors specialize in emerging markets. These people usually charge a percentage of assets under management for their services. Before paying, make sure they're doing the work that they claim to do. Ask to see verified performance records and talk to their references. Otherwise, you may be better off in an emerging market mutual fund, even though it seems less glamorous than having your own personal money guy.

Diversifying your investments

In any market, the easiest way to improve your long-term return and manage your risk is to diversify. If you limit your emerging market investments to the long-term, risk-bearing part of your portfolio, and if you invest in a range of countries and industries, your overall risk is greatly reduced because you have the rest of your portfolio in less-risky, more-liquid assets.

When you diversify, don't just go after a grab bag. Instead, look at a mix of emerging markets. They range from almost developed to barely modern, from natural-resources economies to technology-driven economies, from hard currencies to those that are difficult to exchange. If you have exposure to a little bit of each, then the unique risks in any given market will be offset by unique advantages in others.

A mutual fund or an ETF invests in a variety of securities, but it's not necessarily a diversified investment. Some emerging market funds invest only in one country, and that country's major businesses may all be in the same industry. With such a fund you have more diversification than if you purchase shares of stock in one country, but you aren't well diversified across emerging markets.

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