Investing in Emerging Markets

The United States is the largest economy in the world by far, accounting for more than a quarter of the world’s gross domestic product (GDP) in 2022. Yet we make up less than 5% of the global population.

Most of humanity doesn’t enjoy the same standard of living that we do — at least, not yet. Developing countries are full of people working hard to offer their children the kind of life we take for granted in America. And every year, more of them succeed.

In investing parlance, these developing countries are called emerging markets. Investing in emerging markets isn’t just good for the conscience — it can also be a potentially profitable way to diversify your investment portfolio.

Emerging markets are countries with small, volatile and fast-growing economies. They’re sometimes called developing economies or developing countries.

Emerging markets are often contrasted with so-called “established markets” or “advanced economies” like the U.S., which tend to be wealthier and more stable, but also slower-growing.

Five countries that make up the “BRICS” acronym — Brazil, Russia, India, China and South Africa — are some of the most prominent examples of emerging markets, and they’re good examples of why emerging markets are of interest to investors.

The U.S. economy grew about 58% between 2012 and 2022, the latest year for which complete international data is available ^[0]

Source: Federal Reserve Bank of St. Louis. Data is current as of Apr. 5, 2024.

Index provider MSCI classifies 24 countries as emerging markets ^[0]

Sources: MSCI and VettaFi. Data is current as of Apr. 5, 2024.

You may notice that a few other notable emerging markets, such as Russia, are also missing from this table.

There is no universal standard for noting which countries are emerging markets, and indexers like MSCI often have geopolitical concerns to work around. Russia, for example, is an emerging market by most definitions. But it’s largely unavailable to Western investors for reasons related to the Russia-Ukraine war, so MSCI stopped tracking it in 2022.

Investing in emerging markets might sound advanced or out-of-reach for novice investors, but there’s a strong argument for diversifying outside of the U.S. Even simple portfolios, such as those that contain only two or three funds, often include some exposure to international stocks. After all, a stock market crash in the U.S. might not hit international markets as hard.

In theory, faster GDP growth in emerging markets should also translate into faster stock market growth, but this doesn’t always work out in practice. Many of the ETFs listed above have underperformed the S&P 500 over the last five years, for a variety of reasons.

Some emerging markets, such as Kuwait and Saudi Arabia, have energy-dominated economies that tend to boom when oil prices are high, and decline when they’re low. Others, such as Poland and Turkey, have unique security risks because they border active war zones.

There’s a common thread between these underperformances: Emerging markets tend to be less stable than established markets. They may be faster-growing, but that fast growth is more vulnerable to interruptions, like shifts in global resource markets or armed conflict.

One way to manage this kind of risk is by investing in several emerging markets at once, through a diversified emerging markets ETF, rather than a country-specific one.

This diversified approach to emerging markets investing is quite popular — and there are a variety of global emerging markets ETFs available to U.S. investors.

Below is a list of the five emerging markets ETFs with the lowest expense ratios and more than $1 billion in assets under management (AUM).

Source: VettaFi. Data is current as of Apr. 5, 2024 and for informational purposes only.

Of course, it’s worth researching an ETF before you buy it, just as you would research stocks. Different emerging markets ETFs may have different holdings — and if you’re looking for exposure to a specific company in an emerging market, you may want to consider investing in it directly.

There are a few emerging market stocks that are directly listed on U.S. exchanges — largely bank stocks. For example, HDFC Bank, India’s largest bank, trades on the New York Stock Exchange under the ticker “HDB.”

Some others are available via over-the-counter (OTC) markets — although it’s worth checking an OTC emerging market stock’s trading volume on a website like Yahoo Finance or Google before buying it. Buying a low-volume OTC stock at a good price can be tricky.

Even large conglomerates like South Korea’s Hyundai (HYMTF) are largely overlooked by U.S. investors because they trade OTC. They may only change price a few times per trading day due to a lack of buyers and sellers. That can result in buy or sell orders going through at suboptimal prices, or not going through at all. Limit orders can somewhat mitigate this risk.

A third way to invest in individual emerging market stocks is to open an account with a broker that allows Americans to trade directly on foreign stock exchanges. However, only a few brokers offer this feature, and those that do may have special requirements for would-be foreign stock traders.

It’s also worth considering that you may be subject to the investment taxes and laws of the host country while investing directly in its stock market.

Neither the author nor editor owned positions in the aforementioned investments at the time of publication.