Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn
About

News

Are emerging markets still worth the risk?

Marco Caprotti  |  11 May 2021Text size  Decrease  Increase  |  
Email to Friend

Equities in emerging countries are slowing down after a good run over the last year. Traders and money manager are now starting to wonder if it still makes sense to focus on an asset that has always been considered useful in terms of diversification but which, even when things go well, carries abundant risks.

The Morningstar Emerging Markets Index in the last month (up to May 6) gained just 0.1 per cent, bringing the year-to-date performance to 4.9 per cent (18.4 per cent in 2020).

In four weeks, the Global Markets basket recorded 2.25 per cent (9.7 per cent since January; 16 per cent in 2020).

Morningstar Emerging Markets Index vs Morningstar Global Markets Index YTD

Morningstar Emerging Markets Index vs Morningstar Global Markets Index YTD

Source: Morningstar

“The road to successful investing in emerging markets is littered with holes and risks being expensive,” says Morningstar manager research analyst Daniel Sotiroff.

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

“The dangers facing investors in these countries are numerous and insidious. The problem is that traditional risk measures do not adequately capture elements ranging from bad corporate governance to political problems.”

Political risks

The political question, which is often linked to corruption phenomena, should not be underestimated. One of the most notable cases came to light in late 2015, when executives at Brazilian state oil company Petrobras became embroiled in an intricate web of bribes made up of company contractors, executives, and politicians. The scam drained the company's coffers while it lined the pockets of the parties involved.

"The harmful behavior of emerging-markets executives is nothing new," says Sotiroff. “We saw a lot of them in Russia in the late 1990s, when the country was trying to transition toward a capitalist democracy.”

More recently, in the late 2000s, it emerged that the (state-owned) natural gas giant Gazprom had sold off several major natural gas reserves to executives of the same company and some of their family members.

"These two cases show another distinguishing feature of emerging markets," says Sotiroff.

“Petrobras and Gazprom are companies that are partially or largely owned by their respective governments--a much more widespread phenomenon in emerging markets than in developed economies.

"State ownership increases the risk because the interests of politicians are not always in line with those of investors.

"Companies usually have the goal of maximising profits for shareholders, while the responsibilities of governments include the security of resources, foreign policy, and social welfare, to name a few. "

Fragile economies

Another risk of emerging areas is given by national economies that are usually more fragile in these areas than in developed areas such as the United States, Western Europe, and Japan. "This contributes to the volatility of their stock markets and can lead to the closure or even the collapse of entire financial markets," says Sotiroff.

According to the analyst, another element to consider is that the geographic composition of the baskets dedicated to emerging markets tends to change more frequently than that of the developed baskets. “And this leads to higher portfolio turnover,” he explains.

In the midst of all this, also consider the high costs of this type of investment that derive from having to do more research on shares that are often not very liquid. "There are also currency issues to consider. In the past we have also seen cases in which local turmoil has forced some emerging markets to close for long periods," says Sotiroff.

Better to leave emerging markets alone, then? “Overall, these risks don't paint a rosy picture, but that doesn't mean investors should avoid developing countries altogether,” the analyst says.

"On the contrary, dealing with greater dangers further underlines the importance of diversification when moving into these areas."

Morningstar medalist emerging market funds (Australian domiciled)

Emerging Market Funds

Source: Morningstar. Note: Fidelity Global Emerging Markets ETF (ASX: FEMXis currently "Under Review"

è Giornalista di Morningstar in Italia.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend