Understanding Emerging Markets

"Emerging markets may be a euphemism but it is also a declaration of hope and faith," Mark Mobius has said. "Although some of the stock markets of developing nations may sometimes seem `submerged,' they are generally emerging into bigger and better things."

Such a definition of emerging markets expresses the typically optimistic view of people specializing in this branch of equity investment. Certainly, this relatively new focus of investor enthusiasm is always exciting with something happening all the time, somewhere in the world, with the opportunity for huge profits. Investment returns in some emerging markets have the potential to exceed those in the developed world.

But equally, for the dedicated emerging market investor, there are considerable challenges: the frequent frustrations of a lack of common standards and a lack of information, grueling travel schedules, language problems and cultural suspicions. And, of course, as the Asian crisis and subsequent global economic events have confirmed, stock markets and currencies in the developing and formerly communist worlds can be highly volatile, reacting strongly to international investor sentiment and economic and political changes.

Investments in emerging markets can result in spectacular returns, positive or negative. But picking potential winners, at the level of either country or company, is very difficult. There are frequently problems in comparing the relative merits of companies across markets: financial reporting and accounting standards vary, and indicators such as price-to-earnings ratios are often unreliable for international comparisons. Countries employ a variety of accounting conventions in their treatment of corporate profits.

It is clear that emerging markets carry considerable risks, including illiquidity, lack of transparency and sharp swings in prices. Individual investors seeking a stake in these markets should be either thinking long-term or prepared to take substantial risks. They should also consider carefully what proportion of their portfolios they can reasonably afford to commit to such markets.