Finance
Key Characteristics of Emerging Markets for Investment
Last updated: Jun 7, 2021 • 4min read
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Finance
Last updated: Jun 7, 2021 • 4min read
Emerging markets have long attracted investors seeking growth beyond the steady but often modest returns of developed economies. Markets in regions such as Asia, Latin America, Africa, and Eastern Europe offer dynamic potential—rapid GDP expansions, demographic dividends, expanding middle classes, infrastructural upgrades, and technological leaps. Yet, investing in emerging economies also involves complexity and uncertainty. Volatile regulatory frameworks, currency fluctuations, geopolitical tensions, and liquidity constraints are among the challenges that distinguish these markets from more established ones.
For wealth managers, asset allocators, and institutional investors, understanding the key characteristics of emerging markets is essential. Recognising their underlying growth engines, their cultural and socio-political contexts, ESG considerations, and their evolving regulatory landscapes can guide better decision-making and portfolio construction. In this article, we delve into these defining attributes, providing insights into how advisors can balance risk and opportunity, anticipate structural shifts, and build resilience into emerging market strategies.
By examining these factors in detail, we also highlight why emerging markets deserve careful attention. They not only offer diversification benefits but can serve as catalysts for innovation, early adoption of technologies, and unique sectoral opportunities. Ultimately, investors who appreciate both the potential and the pitfalls of emerging economies stand better positioned to harness their growth stories and achieve long-term success.
One of the most compelling reasons investors look to emerging markets is their typically higher growth rates. Compared to mature economies burdened by ageing populations and slower expansions, emerging markets often enjoy favourable demographics, rising productivity, and industrialisation.
Key Points:
Young and Growing Populations: Many emerging economies boast a youthful demographic profile, driving consumer demand, entrepreneurship, and innovation. As working-age populations grow, so do consumption patterns, spurring domestic markets and improving fiscal stability.
Urbanisation and Expanding Middle Classes: Rapid urbanisation leads to infrastructure development—transportation networks, utilities, and housing—and cultivates middle-class consumers with disposable income. This creates fertile ground for sectors like retail, healthcare, education, and e-commerce.
Structural Economic Transformations: Emerging markets may shift from agrarian or resource-based models to manufacturing- or service-oriented economies. Such transitions can yield productivity gains, open new investment frontiers, and offer investors a chance to enter industries at earlier development stages.
Implications for Investors:
Growth potential can reward long-term investors willing to endure higher volatility. Advisors must identify sectors best positioned to benefit from demographic transitions—healthcare for ageing segments, digital payments for a tech-savvy youth, sustainable infrastructure for expanding cities.
Diversifying across multiple emerging markets can spread risk, as not all follow identical growth trajectories or face similar macroeconomic challenges.
While emerging markets offer opportunity, they also come with heightened regulatory uncertainty. Governments may impose sudden capital controls, alter tax laws, or nationalise resources. Political cycles can bring policy reversals, corruption scandals, or abrupt leadership changes, all of which can disrupt investments.
Key Points:
Inconsistent Policy Enforcement: Regulatory bodies in emerging markets may lack the institutional strength of their developed counterparts. Enforcement of accounting standards, minority shareholder protections, or environmental regulations can vary greatly.
Government Intervention and Protectionism: Some governments might use tariffs, trade barriers, or resource nationalism to protect local industries or meet political agendas. Such measures can impact foreign investors, requiring careful due diligence and adaptable strategies.
Positive Regulatory Reforms Over Time: On the flip side, many emerging markets strive to align with international norms, strengthening investor protections, improving corporate governance, and adopting transparent frameworks over time. Recognising countries undergoing positive reforms enables advisors to enter markets as conditions improve.
Implications for Investors:
Advisors must integrate political risk assessment into portfolio construction. Engaging local legal experts, monitoring policy announcements, and understanding cultural power structures help navigate uncertainty.
Considering scenario analysis—forecasting different policy futures—can inform strategic asset allocation, hedging currency risks, or selecting more defensible sectors like consumer staples or healthcare that may be less exposed to policy swings.
Emerging markets reflect diverse cultural values, social norms, and historical legacies that influence consumer behaviour, corporate governance, and investor sentiment. Appreciating these cultural and behavioural nuances is crucial for understanding market dynamics and forging relationships with local stakeholders.
Key Points:
Local Consumer Preferences and Brand Loyalty: Cultural traditions may dictate spending patterns. For instance, in some markets, strong family ties and collectivist norms shape saving and investment decisions. Understanding local tastes can aid in identifying promising domestic brands or niches.
Family-Owned Conglomerates and Governance Styles: Many emerging economies feature family-controlled companies. Assessing their governance structures and ability to adapt to global standards is vital. Family businesses may prioritise legacy and social status over short-term returns, influencing strategic decisions and investor outcomes.
Cultural Barriers to Market Participation: Language differences, lack of financial literacy, or historical distrust of financial institutions can affect retail investor participation and market liquidity. Advisors must consider these factors when evaluating market depth and the potential for stable, local investor bases.
Implications for Investors:
Advisors who embrace cultural competence and engage local experts can identify hidden opportunities and reduce misinterpretation of market signals.
Considering cultural dimensions can also guide ESG integration, ensuring that investments respect local traditions, labour practices, and community relations.
Emerging markets often grapple with less developed financial infrastructure, restricted liquidity, and limited product offerings. While developed markets boast broad derivative markets, extensive ETF selections, and deep pools of institutional capital, emerging markets may be more constrained.
Key Points:
Limited Liquidity and Higher Trading Costs: Narrow bid-ask spreads and thin trading volumes can complicate entering or exiting large positions without impacting prices. As a result, investors may require longer holding periods and careful order management.
Fewer Sophisticated Instruments: Options, futures, or complex hedging tools may be less accessible. Investors may rely on a narrower range of products to achieve diversification or risk mitigation.
Improvements Over Time: As emerging markets integrate into global financial systems, infrastructure improves. Stock exchanges modernise, custodial services become more efficient, and regulatory reforms attract foreign participants.
Implications for Investors:
Patience and long-term horizons matter. Illiquidity may discourage short-term trading but rewards investors who seek sustained exposure to growth opportunities.
Advisors should evaluate market entry strategies, considering partial entries, local fund managers, or co-investments with established local partners to navigate operational complexities.
Currency volatility is a defining characteristic of many emerging markets. Fluctuating exchange rates can amplify gains or losses, while capital controls may affect repatriation of funds, dividend distributions, or sudden liquidity constraints.
Key Points:
Currency Depreciation and Inflation: Periodic currency depreciations, driven by commodity price swings or political instability, can erode returns for foreign investors. High inflation periods can also undercut local bond yields, complicating fixed income strategies.
Capital Control Restrictions: Some emerging economies impose restrictions on foreign investment inflows or outflows to stabilise their currencies or protect local industries. Advisors must understand these rules to ensure compliance and maintain liquidity options.
Hedging and Currency Allocation: Selecting hard-currency bonds or using derivatives can mitigate currency risk. Diversifying across multiple emerging markets with different currency profiles further reduces exposure to a single failing currency.
Implications for Investors:
Incorporating currency considerations into scenario analysis and risk management frameworks ensures that currency shocks do not blindside portfolios.
Advisors who maintain relationships with local banks or fund managers may access better hedging instruments or gain insights into currency regimes and policy trends.
Emerging markets face ESG-related challenges—such as environmental degradation, labour issues, or corruption risks—yet they also present opportunities to support positive change. Investors who integrate ESG criteria can identify resilient companies poised for long-term success and avoid reputational hazards.
Key Points:
ESG Integration as Risk Mitigation: Companies neglecting environmental standards or governance practices risk lawsuits, boycotts, or regulatory crackdowns. ESG integration thus reduces the probability of catastrophic setbacks.
Impact and Stewardship: Engaged owners can use their influence to encourage better corporate behaviour in emerging markets, promoting better governance, transparency, and sustainable practices. This stewardship contributes to market maturity over time.
Capturing Thematic Opportunities: Investing in renewable energy infrastructure, sustainable agriculture, or social enterprises in emerging economies can yield both financial returns and measurable impact. Clients who prioritise ESG appreciate these dual benefits.
Implications for Investors:
ESG due diligence demands careful research. Advisors must differentiate between authentic ESG commitment and greenwashing, ensuring that chosen investments genuinely align with investor values and structural sustainability trends.
Long-term ESG commitments can boost portfolio resilience, especially as global ESG standards tighten and local regulations evolve.
Investing in unfamiliar territories often involves emotional and cognitive biases. Emerging markets’ volatility, complexity, and news flow can trigger fear or euphoria, affecting investor and client psychology.
Key Points:
Loss Aversion and Panic Selling: Sharp downturns in emerging markets can prompt panic-driven decisions. Prepared clients who understand volatility and have faith in a strategic plan resist impulsive actions, sticking to the course.
Emotional Attachment to Certain Regions or Themes: Some clients may favour their home regions, feel patriotic pride in supporting local industries, or attach symbolic significance to certain investments. Advisors must balance emotional drivers with rational allocations.
Communicating Complexity Clearly: Advisors who explain emerging market dynamics accessibly—using analogies, scenario analyses, and historical comparisons—help clients maintain confidence. Educating clients reduces anxiety and fosters rational, long-term thinking.
Implications for Investors:
Incorporating behavioural finance insights when advising clients on emerging markets improves decision quality. Advisors can normalise volatility, highlight diversification benefits, and emphasise scenario-tested resilience to mitigate fear-driven mistakes.
Engaging clients in the scenario construction process and inviting their input on thematic directions can enhance their emotional comfort and sense of control.
Emerging markets often serve as testing grounds for new technologies and business models. Demographic trends like rapid urbanisation and youthful populations favour digital adoption. Smartphones, fintech platforms, and e-commerce ecosystems evolve swiftly, creating distinct growth stories.
Key Points:
Mobile Finance and Leapfrogging: In some emerging economies, mobile payment systems and digital banking leapfrog traditional infrastructures. This can foster entrepreneurial ecosystems ripe for venture capital or thematic funds focusing on fintech and digital services.
Adoption of Renewable Energy and Smart Cities: Scarcity of legacy systems may accelerate the adoption of renewable power, electric mobility, or urban planning solutions. Such transitions offer long-term thematic opportunities aligned with sustainability and efficiency imperatives.
Technology’s Role in Improving Market Infrastructure: As exchanges adopt better trading platforms, reporting standards, and digital KYC processes, emerging markets become more accessible and transparent, mitigating some historical concerns about liquidity or data reliability.
Implications for Investors:
Keeping abreast of technological disruptions helps identify sectors poised for outsized returns. Advisors can propose thematic investments in tech-savvy emerging markets, capitalising on demographic dividends and entrepreneurship.
Recognising the digital divide is critical. Not all emerging markets advance at the same pace, and understanding local innovation ecosystems guides sector selection and portfolio weighting.
Emerging market investing can seem arcane or intimidating to clients unfamiliar with currency risks, political factors, or ESG standards in distant locales. Advisors who invest time in client education and set realistic expectations foster trust and stability.
Key Points:
Client Education as a Trust-Building Tool: Explaining why certain emerging markets are chosen, how portfolio allocations are stress-tested, and what contingency measures exist encourages clients to remain patient and rational.
Transparent Fee Structures and Performance Reporting: Complexity should never obscure fee disclosures or track records. Clients appreciate transparent breakdowns of costs, the rationale behind strategic choices, and data-driven performance reviews comparing emerging markets against relevant benchmarks.
Long-Term Partnership Models: Advisors who position themselves as mentors and strategic partners rather than just product providers differentiate their services. Engaging clients with periodic scenario updates, thematic briefings, and macroeconomic insights sustains interest and confidence.
Implications for Investors:
Well-informed clients are more resilient and loyal. Education and communication, especially around emerging markets’ unique risks, can prevent panic-driven investment moves during downturns.
Emphasising a long-term narrative and highlighting the advisor’s continuous research, relationship networks, and adaptability reassures clients that their wealth is managed thoughtfully.
Emerging markets evolve, sometimes rapidly. Economic reforms, regulatory improvements, geopolitical realignments, and climate pressures can alter market landscapes significantly. Advisors must remain dynamic, continuously upgrading their knowledge and analytical tools.
Key Points:
Regular Market Reviews and Position Adjustments: Advisors who frequently reassess holdings, adjust allocations in response to economic signals, and refine hedging strategies ensure that portfolios remain fit for changing conditions.
Professional Development and Networking: Staying current with industry research, attending conferences focused on emerging market trends, and forming ties with local experts enhance the advisor’s ability to spot early warning signs or undiscovered opportunities.
Scenario Testing and Evolution Over Time: Scenario analysis is not a one-off exercise. Repeating scenario-based planning sessions enables advisors and clients to reflect on previous assumptions, learn from past market responses, and refine strategies as new data emerges.
Implications for Investors:
Those who work with advisors committed to continual improvement, openness to emerging asset classes, and proactive scenario planning benefit from sustained relevance in their portfolios.
The capacity to adapt fosters resilience, ensuring that the portfolio’s rationale remains sound even as the economic and political tapestry of emerging markets transforms.
Emerging markets present a rich tapestry of growth prospects, cultural dimensions, regulatory complexities, ESG challenges, and behavioural nuances. Understanding the key characteristics that define these markets is essential for advisors aiming to guide clients towards informed, resilient decisions in these arenas.
By acknowledging the significance of long-term thinking, mitigating policy risks, integrating ESG factors, embracing cultural competence, and mastering scenario planning, advisors position themselves to identify opportunities and navigate uncertainties. Clients who comprehend the distinct nature of emerging markets, appreciate transparent communication, and trust in their advisor’s risk management and adaptation strategies can better embrace these dynamic environments.
As technology, global trends, and demographic shifts continuously reshape emerging markets, advisors must remain agile and committed to lifelong learning. Only by doing so can they deliver lasting value, help clients harness emerging market potentials, and achieve a balanced blend of returns, purpose, and security for current and future generations.
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