For my very first article I wanted to explore a topic that I find incredibly interesting and that is emerging markets. I explain what they are and their characteristics, why firms tend to invest in them and finally move onto analysing a case study.
What exactly is an emerging market? An emerging marketeconomy describes a nation’s economy that is progressing towards becoming more advanced and this is usually caused by meansof rapid growth and industrialization. Generally speaking emerging markets will tend to have lower incomes per capita, higher unemployment and lower levels of economic activity in comparison to a fully developed nation, such as the United States. However, an emerging market will tend to have much higher rates of growth compared to that of a developed country, as a result the rate of return for investors can potentially be incredibly high. Emerging markets that you might be familiar with include Brazil, Russia, India and China (also known as the BRICS).
There are two main advantages of investing within Emerging markets: high growth rates and diversification. As I mentioned before the high growth rates make investing into emerging markets particularly appetising for investors, whether it be into equities, fixed income, foreign currency, real estate or commodities. Usually an asset manager will aim to diversify a client’s portfolio, because diversification of a client’s portfolio allows risk to be spread. When investing into different emerging markets it means that if one country isn’t doing as well economically then can be offset by growth in another country.
Now we begin to look at some of the potential negatives of investing within emerging markets and the main one is the risk associated. Whether this be political, economic or the risk associated with investing within them. Firstly, most emerging markets have some form of political instability and as a result of political unrest, this can cause severe problems for the economy and investors. There are quite a few economic risks involved within emerging markets. Emerging markets may have insufficient resources, varying rates of inflation and markets that are incredibly unregulated. Finally, there is the risk associated with currency. When comparing the currency of the emerging market to the US Dollar then they can be extremely volatile, therefore any potential investment returns could be cancelled out if the currency drops in value or is devalued.
I think that this is a good time to introduce the concept of Sharpe Ratio’s. It was derived in 1966 by William Sharpe and is a risk/return measure used in finance. It ultimately a measure of risk per unit of reward by describing “how much excess return you are receiving for the extra volatility that you endure for holding a riskier asset”. As a result, emerging markets will tend to have a higher Sharpe ratio’s.
How much excess return you are receiving for the extra volatility that you endure for holding a riskier asset
For my case study I will combine both buy and sell side. Bharti Airtel, India’s largest mobile network, wanted to make a big international acquisition. Slightly going off topic, but companies tend to merger and make acquisitions in order to have a larger percentage of the market share. It allows the company to grow and thus there is the potential for much higher profits. As a result, Bharti Airtel eventually bought most of the African assets from Zain group at a price of $10.7bn. This acquisition makes Bharti the “biggest mobile group operating exclusively in emerging markets”, as a result an investor buying equities for Bharti could also see high returns if this acquisition has a major impact.
Overall emerging markets are all about high risk and high reward. They can provide short, as well as long term investment opportunities. However, from just a quick overview it seems as though there are many drawbacks and that the risks outweigh the benefits. I think that it would be a good financial instrument to use if the client already has quite a diverse portfolio and is looking to diversify even further.
Hello I am Rohan.