Emerging market equities: enduring risks to capture emerging growth.

• Author: Ulbrich, Scott
• Position: Money Talk

Emerging markets are broadly defined as countries or regions with above average economic growth prospects. According to the International Monetary Funds World Economic Outlook (April 2010), emerging and developing economies are expected to grow close to three times faster than advanced economies by the year 2015. As the United States faces a potential slower period of domestic economic growth, investors have an increased appetite for exposure to faster-growing emerging markets. 65 DATS Trucking/Overland Petroleum Don L. fpsoo 65 DATS Trucking/Overland Petroleum Don L. fpsoo

The Tradeoff: Risks vs. Returns

Emerging market equities have rewarded patient investors over time. As emerging markets mature, their citizens may enjoy a higher standard of living, spurring a new source of demand for food, clothing, technology, business services and other opportunities that more developed markets enjoy. Investors expect this new source of demand to translate into corporate earnings growth and higher equity returns for companies with exposure to these regions.

Over the last decade, investors have experienced stronger equity performance in emerging markets than developed markets. For the 10-year period ending March 31, 2012 the MSCI Emerging Market Index experienced an annualized gross return of 14 percent compared to a 4 percent total return for the S&P 500 Index. While the growth prospects of emerging markets are attractive, the valuation of emerging markets equities is an important factor to consider.

Diversification benefits of emerging markets may be less than expected. Emerging markets often have growth drivers that are independent from those of the global markets. However, due to the globalization of equity markets, correlations between emerging and developed markets have been increasing. That being said, there is still a diversification benefit of adding emerging market equities to a portfolio.

Investing in emerging markets comes with above average risk. While higher growth is projected in emerging countries, there are risks that investors may need to endure to participate in this growth. Emerging markets can have political and social instability, poor infrastructure, unstable financial markets, currency risks, limited economic diversification, weak corporate governance policies and a host of other issues when compared to more developed countries. It is these risks that investors expect to be compensated for through higher expected returns on...