Potential Payoffs in Emerging Markets - dummies

Potential Payoffs in Emerging Markets

By Ann C. Logue

Investing in emerging markets can generate a great return, even compared with developed markets. On an annualized basis and for the ten years ending December 31, 2009, the MSCI (Morgan Stanley Capital International) U.S. index for developed countries was down 3.50 percent. Meanwhile, the best-performing emerging region, Latin America, was up 13.88 percent during the decade, and the top-performing country, Colombia, was up 27.14 percent. Those impressive numbers represent a nice payoff for investors.

Emerging markets have high risk to go along with the high return potential. Emerging-market investments have ways of generating returns that are theirs and theirs alone:

  • Emerging markets equal rapid growth: When an economy makes its debut on the global stage, it’s usually in a state of rapid growth, which makes sense because a small economic base tends to produce bigger returns than a large base. The economies of emerging-market countries tend to be relatively poor. The countries need everything: buildings, roads, and airports; planes, trains, and automobiles; jeans, jerseys, and jewelry. They need these things in greater quantity than, say, people in Canada or Australia or Germany do. And all that demand adds up to economic growth.

  • Opportunities in new technology, new materials, and new ideas: Many international investors approach the developing world as a source for cheap stuff they can bring home. That’s true in some markets, especially those that are rich in raw materials. However, the real resource lies with people. The potential for human beings to come up with new businesses, new technologies, and new ideas is huge.

    The new ideas and new technologies are where emerging markets have the potential to shine in the long term. People without reliable electric utilities have learned how to use solar power, which can benefit cost-conscious and environmentally conscious consumers everywhere. Those living near tropical rain forests understand the medicinal properties of plants that have the potential to improve life for people everywhere. Folks in India looking to make entertainment for themselves write songs and make movies that appeal to everyone.

  • Profits through currency exchanges: When you invest in another country, you almost always have to buy that country’s currency to buy the investment. Then when you sell the investment to use the proceeds elsewhere, you also sell the currency. The change in the currency’s value while you own the investment may enhance — or diminish — the investment’s value.

    Currency transactions add risk to international investing, but they also add return. In general, exchange rates are determined by supply and demand, just as prices are in any other market. And in general, if an economy grows and has a lot of economic activity, then its currency should be in great demand and should become more valuable.

    Currencies sometimes become less valuable over time. This drop may be because of economic changes, or it may be because the currency becomes overvalued and corrected, or it may just be that the emerging-market currency is fine but your home currency has become more valuable for other reasons.