Identify Emerging Markets for Your Investment Portfolio - dummies

Identify Emerging Markets for Your Investment Portfolio

By David Stevenson

To discover which countries comprise the EM (emerging market) asset class, check out the equity-market index that many mainstream and hedge-fund managers use as a benchmark. The MSCI Emerging Markets Index was founded in 1988 and is now tracked by hundreds of different funds. Collectively the country stock markets included in this index moved from about 1 per cent of the global equity opportunity in 1988 to 14 per cent in 2010.

These EM countries have changed incredibly over the last decade. Many of them used to be net importers of capital, but today many of their governments are international investors themselves, through the creation of sovereign (government) wealth funds where the state saves up extra revenues for the future.

The ‘mainstreaming’ of EM among western investors hasn’t been entirely pain-free. EM stocks in particular can be very volatile in terms of pricing – shooting up and down in value as investors switch risk on and off.

This table looks at MSCI Emerging Markets Index data from November 2012. Over the previous 12 months, many EM regions fell in value, with emerging Eastern European markets in places such as Hungary and Romania being especially badly hit. That’s also true for the last three and five years.

But look at the far right-hand column in the table showing annualised returns over the last ten years: these figures indicate that EM stocks overall have returned an average gain of 10 per cent per year for the last ten years.

The EM Story in Numbers (Using US Dollars and as at 15 November
Annualised Historical Returns (%)
MSCI Index 1 Year 3 Years 5 Years 10 Years
BRIC (Brazil, Russia, India, China) –5.180 –5.950 –9.180 16.370
EM (Emerging Markets) 0.530 0.410 –5.080 12.790
EM Asia 3.570 2.050 –4.720 11.050
EM Eastern Europe –7.110 –4.070 –12.600 10.240
EM Europe & Middle East –1.990 –1.550 –9.280 10.410
EM Far East 3.760 2.820 –4.150 10.440
EM Latin America –7.260 –4.130 –4.540 19.160

Source: MSCI and iShares

The table digs a little deeper into these equity-market returns and highlights the massive volatility on a year-by-year basis. In a good year, such as 2009, EM stocks can increase by 78 per cent in value and even in an average year returns of 20 or even 30 per cent are possible.

These statistics serve as a reminder that investors drop EM stocks when worries about a global recession increase sharply. When the global markets hit a turbulent patch in 2008, EM stocks declined by a whopping 53 per cent overall.

Annual Returns from the MSCI EM Index
Year-by-Year Returns Index Returns (%)
2011 –18.42
2010 18.88
2009 78.51
2008 –53.33
2007 39.39
2006 32.17
2005 34.00
2004 25.55

Source: MSCI

That volatility in EMs also shows up in the constituents of the index. In this table you can see that countries such as Russia and India now comprise only around 6 per cent of the global index. In good years, when the bulls were rampant, these countries comprised as much as 10–15 per cent of the index.

Allocation of the MSCI EM Index (Ten Largest Countries as at 15
November 2012)
Country Percentage of Fund
China 17.84
South Korea 15.17
Brazil 12.38
Taiwan 10.72
South Africa 7.62
India 6.83
Russia 5.77
Mexico 5.05
Malaysia 3.77
Indonesia 2.85
Total 88.00

Source: iShares at

Like all growth markets EM markets are volatile, which is where hedge funds come in handy because they aim to mitigate that risk. Using a hedge-fund approach you can cut the volatility by more than half without giving up half the returns.