The MSCI Emerging Markets Index contains 24 countries representing 15% of the investable market. 29 years ago there were just 10 countries in the index, representing just 1% of the market.
In the decade from 2003, emerging markets went from 24% of worldwide GDP up to 43%. Anyone savvy enough to invest in this sector has been very well rewarded with average annual returns of up to 9.6% pa over the past 10 years.
Unfortunately, there is no standard, widely accepted definition of an emerging market. Classification systems vary widely but are generally based on the World Bank’s methodology for classifying markets as developed or developing. Countries with high levels of per capita income are classified as developed. Those countries with low, middle, and upper-middle incomes per capita, relative to incomes in developed countries are classed as developing or emerging. Countries with even lower levels of income per capita are deemed frontier markets. These tend to have more volatile, less diverse stock markets and the companies have poorer levels of corporate governance.
When indexers such as MSCI decide who to add to their index they look at each country’s economic development, size, liquidity and market accessibility in order to be classified in a given investment universe. If a country is awarded “emerging market” status it means that both active and passive funds which use the MSCI Emerging Markets index as a benchmark can invest in companies listed in that country – resulting in significant foreign investment. Recently, MSCI has announced plans to include China ‘A’ shares [those listed on the mainland, rather than Hong Kong] into its emerging market indices. This will further weight the China allocation in a passive fund tracking this index.
Emerging markets investing is not risk-free. Because of the nature of these countries’ development, emerging economies’ stock markets are liable to be volatile. Macro events, such as the global recession hits emerging markets hard; their economies and stock markets have less diverse revenue streams and they tend to be too reliant on exports and commodities which are controlled by external factors.