| As more established world economies endure a time of slumping growth prospects, emerging markets are simultaneously blooming, and they may be more relevant than ever. Emerging markets (EM) can arguably be a powerful complement to a largely US-based investment portfolio, but they are often misunderstood. What are they exactly, and what are their benefits and tradeoffs? What's an "emerging" market? Emerging markets usually refer to economies showing strong economic growth while showing some characteristics of a developed economy. In other words, they are countries in transition, usually from a place of "developing" to "developed." Which countries are emerging? Research organizations and data providers each have slight variations in what they determine as an EM country. For example, the IMF has classified 23 nations as emerging, the S&P picked 23 and MSCI has 24 countries on the list. What's the appeal? - Economies and markets mismatch: We may be underestimating the benefits of EM because the size of their financial markets is usually small relative to the size of their economies. For example, emerging countries account for 45% of the world's GDP, but their stock markets are worth only 27% of the world's total.
- Bright outlook: Strong global GDP growth is expected, according to the IMF. They forecast an average annual GDP growth of 4% for emerging markets in 2023-2024, compared with 1.5% for developed economies. That's positive for emerging market equities, which tend to perform better when demand for commodities and exported goods is strong.
- Diversification for US investors: EM markets are less correlated with US markets, and can also offer currency diversification, which will be useful when the US dollar is weak.
- The long-term growth trends: According to Schroders, EM represent roughly 87% of the world population, 45% of global consumer spending, and in less than 20 years, they are expected to account for 57% of the world's total GDP. Other growth drivers include urbanization, tech & industrialization driving economic growth and the rising middle class driving consumer spending.
What's not so appealing? - Higher risk, higher volatility: EM stocks are generally more volatile than developed market (DM) stocks. Over the last ten years, the standard deviation, which measures volatility, was 30% higher for EM than DM stocks, according to Morningstar.
- Now about that higher volatility: It stems from higher economic risk, political risk, currency risk, and liquidity risk. For example, consider the persistence of the Chinese government's checks and actions towards internet-related companies. And when an EM currency is declining, your investment is worth less when converted to USD. There's also the risk it may be easy to bring money in, but not always to get it out.
Ways to get EM exposure First, determine whether going the passive or active route serves you and your long-term goals best. Do you want to go the way of a low-cost index mutual fund/ETF or pay for the expertise of an active manager? Do you want broad and diverse EM or a single EM country exposure? How much does your risk tolerance allow you to allocate? How long is your time horizon? If you do decide to undertake investing internationally on your own, as always, don't forget to rely on some old-fashioned due diligence. And if you don't have all day to scour the internet for their life story, consider a broad-based basket of emerging market countries through an index fund or ETF. | 
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