EMERGING MARKETS EQUITIES EXPLAINED

What Are Emerging Market Equities?

Emerging market equities refer to shares in companies that are based in nations with developing economies. These countries are typically experiencing rapid industrialisation, improving infrastructure, and accelerating economic growth, but they may not yet meet the income and stability standards of developed economies.

The term "emerging markets" encompasses a range of countries with diverse characteristics, including large economies like China, India, and Brazil, as well as smaller, frontier markets such as Vietnam, Nigeria, or Kazakhstan. The core distinction lies in their transitional economic phase—offering high growth potential but also higher-than-average volatility.

Investing in emerging market equities gives investors exposure to dynamic economies undergoing structural transformation. Much of this growth is driven by demographic shifts, rising consumption, urbanisation, and increasing access to capital. Multinational corporations may also benefit from expanding into these markets, further fuelling domestic companies.

Emerging markets are usually classified based on various criteria by index providers:

• MSCI Emerging Markets Index: One of the most widely used benchmarks featuring 24 countries (as of 2024) including South Korea, Taiwan, and South Africa.
• FTSE Emerging Markets Index: Includes countries with investable, liquid equity markets undergoing progressive development.

These indices help fund managers and investors track the performance of emerging market equities and allocate assets appropriately. Products like exchange-traded funds (ETFs) and mutual funds are typically used to access these equities, offering diversification across multiple countries and sectors.

Key sectors in emerging markets often differ from developed counterparts, with higher weightings in financials, energy, materials, and technology. Furthermore, state influence in many regions can affect corporate governance and shareholder rights, adding complexity to investment decisions.

It’s also important to note the distinction between emerging and frontier markets. Frontier markets are even less developed and may lack liquidity, market infrastructure, and political stability, making them riskier but potentially lucrative for highly risk-tolerant investors.

Emerging market equities attract portfolio diversification benefits because their economic cycles may not correlate closely with developed markets. When combined with their growth potential, this makes them a valuable—if volatile—component in a balanced global portfolio.

Characteristics of Emerging Market Economies

• Lower GDP per capita compared to developed nations
• Rapid industrialisation and urbanisation
• Expanding infrastructure and middle class
• Varied political and regulatory environments
• Higher volatility and currency fluctuations

Overall, emerging market equities represent an exciting, albeit complex, segment of global investments. Their potential for long-term capital appreciation makes them a frequent consideration among growth-oriented and globally diversified investors.

Key Risks of Investing in EM Equities

While the potential growth offered by emerging market (EM) equities is attractive, these investments come with a unique set of risks. Understanding and managing these risks is essential for investors aiming to capitalise on the opportunities without being blindsided by volatility or instability.

1. Political and Regulatory Uncertainty

Emerging markets often experience political instability, abrupt policy shifts, or changes in regulatory frameworks. Elections, political unrest, and government intervention in private enterprise can directly impact market performance. For example, capital controls or sudden tax increases may reduce investor returns or restrict repatriation of profits.

Investors must also contend with inconsistent rule of law and weaker protections for shareholders compared to mature markets. Nationalisation of industries or government-mandated corporate restructuring can significantly affect stock valuations.

2. Currency and Exchange Rate Volatility

Currency fluctuations represent a major risk in EM equity investing. Emerging economies frequently face inflationary pressures, devaluations, or foreign exchange shortages. Since most foreign investors hold assets denominated in local currencies, any depreciation can erode returns when converted back to a base currency like the US dollar or euro.

This foreign exchange risk is often more pronounced in economies with large current account deficits or high levels of foreign debt, making them vulnerable during periods of capital flight or rising interest rates in developed countries.

3. Market Liquidity and Infrastructure

Equity markets in many EM countries suffer from lower liquidity and underdeveloped trading infrastructure. Spreads between bid and ask prices can be wide, and executing large trades may be challenging without moving the market. In times of crisis, liquidity can disappear altogether, compounding losses.

Furthermore, limited financial transparency and less rigorous corporate disclosures increase the difficulty of evaluating companies. This opacity can result in mispricing or higher risks of fraud and misgovernance.

4. Economic Sensitivity

Emerging markets are often heavily reliant on specific sectors such as commodities, manufacturing, or agriculture. They may be vulnerable to global economic cycles and downturns in demand. For example, commodity exporters like Russia or Chile face substantial volatility associated with global oil and metal prices.

Global trade policies, tariffs, or changes in supply chain strategies can disproportionally impact EM economies. The COVID-19 pandemic highlighted how sudden exogenous shocks can impair emerging markets, both financially and in terms of healthcare and governance capacity.

5. Legal and Corporate Governance Challenges

Investor rights and corporate governance standards in EM countries can be less robust. Minority shareholders may have limited recourse against management decisions, related-party transactions, or equity dilution. Board independence and audit quality may not meet international norms.

Additionally, corruption and lack of enforcement mechanisms can affect business predictability and investor trust, increasing the risk premium demanded by the market.

Risk Mitigation Strategies

• Diversify across multiple EM regions and sectors
• Use active management for deeper market understanding
• Hedge currency exposure where feasible
• Monitor macroeconomic indicators regularly
• Invest via established funds with strong track records

In conclusion, emerging market equities carry significant investment risk. However, by systematically evaluating and diversifying risks, investors can harness the high-growth potential these markets offer while cushioning the downside.

Drivers Behind Emerging Market Growth

Despite the inherent risks, emerging markets offer incredibly compelling growth drivers that continue to attract both institutional and retail investors. These drivers are multifaceted and interconnected, spanning demographic trends to innovation and policy reform.

1. Demographic Dividend

Emerging economies typically benefit from youthful, rapidly growing populations. These demographics create a rising labour force and increased domestic consumption. Countries like India, Indonesia and Nigeria are projected to experience significant population growth and urbanisation over the coming decades.

This demographic dividend contributes to:

• Higher productivity and economic output
• Expanding middle class and consumer demand
• Increased demand for housing, education, healthcare and infrastructure

The resulting domestic consumption fuels corporate earnings and drives equity performance across sectors such as consumer staples, financial services, and telecommunications.

2. Technological Leapfrogging

Emerging markets often bypass legacy infrastructure and adopt new technologies directly, a phenomenon known as leapfrogging. Mobile banking, fintech solutions, renewable energy, and e-commerce are notable examples. Kenya’s M-Pesa is a well-known case of innovation originating in an EM context and scaling rapidly.

Fast adoption of digital platforms brings efficiency to both public and private sectors. China’s dominance in e-commerce, India’s UPI-based payment revolution, and Brazil’s growing digital banking scene illustrate how innovation can support robust corporate performance.

3. Policy and Structural Reforms

Many emerging economies are implementing market-friendly reforms aimed at opening up to global investors and liberalising trade and finance. Examples include tax reforms, improvements in fiscal governance, and foreign investment incentives.

Reforms improve investor confidence, support stable macroeconomic environments, and establish long-term growth anchors. Markets such as Indonesia and Vietnam are frequently cited for their progrowth policies and pro-business environments.

4. Participation in Global Supply Chains

As global companies diversify sourcing and production, emerging markets are increasingly integrated into global supply chains. The “China Plus One” strategy is a direct result of multinational corporations seeking operational resilience by investing in other Asian economies like Vietnam, Bangladesh, and the Philippines.

This shift not only supports export-oriented manufacturing but also leads to infrastructure upgrades, capital inflows, and technological transfer, which ultimately boosts local equities.

5. Green Economy Transformation

Emerging markets are becoming critical players in the global energy transition. Countries like Chile, South Africa, and India are investing heavily in renewable energy and sustainable development. These shifts open up vast opportunities in clean technology, alternative energy, and green infrastructure sectors.

With global backing from institutions like the World Bank and climate-focused private equity, EM economies are set to lead in areas of sustainability where developed countries may face legacy constraints.

Investor Access and Institutional Growth

Increased global focus on emerging markets has also resulted in improved market accessibility and oversight. Institutions like MSCI and FTSE have introduced more stringent inclusion criteria, encouraging better governance and transparency.

Moreover, the growth of domestic pension and sovereign wealth funds in countries like Malaysia, South Korea, and Saudi Arabia has added stability and long-term capital to local equity markets.

Emerging markets are no longer peripheral. They account for over 80% of the world’s population and approximately 60% of global GDP (in purchasing power terms). Their importance in global equity portfolios is expected to grow as their economic convergences continue.

With ongoing reforms, youthful demographics, innovation, and deeper global integration, emerging market equities stand as a vital frontier for long-term global investment strategies.