Emerging Markets: Where and What Are They?

Emerging markets are frequently mentioned in economic talk shows and financial journalism. However, you may wonder what makes a market emergent and where can you find ways to invest? Caleb Silver, Editor-in-Chief at Investopedia joins Cassidy Clement, IBKR’s Senior Manager of SEO and Content to discuss.

Summary – Cents of Security Podcasts Ep. 48

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement 

Welcome back to the Cents of Security podcast. I'm Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers. And today I'm your host for our podcast. Our guest is Caleb Silver. He's the Editor In Chief of Investopedia and host of The Express podcast. 

Emerging markets are frequently mentioned in economic talk shows and financial journalism. However, you may wonder what makes the market emergent and where can I find ways to invest? We're going to discuss all of that more.  

So welcome back to the program, Caleb. 

Caleb Silver 

Good to be with you again. Thanks for having me. 

Cassidy Clement 

Sure. So last time we talked about credit cards. We're going to completely switch around here and we're going to go over to emerging markets. So baseline, what exactly are emerging markets? How do they get that terminology assigned to them? 

Caleb Silver 

Emerging markets is kind of a broader name, a bucket name for countries that are not yet total superpowers, although China still fits into some emerging market index funds and ETFs.  

But we're talking about countries like Brazil, South Africa, Poland, Indonesia, South Korea, Thailand.  

A lot in the Pac Rim, but around the world, these are not necessarily countries that have super low incomes. These are developing economies that have pretty good industrial bases, pretty good technology bases and large GDPs, but not yet at the size of the United States. 

Cassidy Clement 

Got it. So we're looking at, let's say, an economy that's going to be transitioning to more of a developed looking nation or economic circumstance.  

You had mentioned some of their systems are going to be a little bit more familiar to people who are, let's say, Europeans or Americans, right? More of a unified, centralized, industrialized, if you will, institutions, right?  

Caleb Silver 

Absolutely. We're talking about countries like India, too. That has a very sophisticated economy, a very large GDP, a huge workforce, big technology base, still considered an emerging market.  

If you take the whole continent of Europe, that is not an emerging market. That is a completely developed market like the United States. But if you take countries within Europe, like a Poland, that is definitely an emerging economy and emerging country and you'll find countries like Poland, countries like India inside index funds or exchange traded funds where you can actually invest in the development of those countries. 

Cassidy Clement 

So in a way, you're kind of looking at it like, OK, if you found an investment in a company that's just starting out, it could be ground floor investment. As that rapid growth grows, so does your investment.  

But for the listeners who are kind of just entering into the space, what are some examples of some emerging markets, country-wise, that you can give? And also paint a little bit of a picture as to why they're developing? 

Caleb Silver 

Yeah, let's take a a country like Vietnam, right? On its own, it’s developing, it's emerging, it has a sophisticated industrial base and technology base, but it's not yet at the size of a Japan necessarily.  

So it is emerging. And it gets a lot of business from countries around the world. If you think about where sneakers are manufactured by Nike, a lot of that takes place in Vietnam. If you think about a lot of where industrial production is happening, that's moved away from China, it's moving into countries like Vietnam, like Thailand. Strong workforces, educated workforces, but also have the benefit of being able to export and import a lot more easily than some countries.  

You got the water, you got to sea there. So it has ports, it has a completely sophisticated economy, just not generating the type of GDP you see in a much more developed economy like a Japan or United States. 

Cassidy Clement 

So you had mentioned something earlier about different types of funds and access to these markets. Initially somebody might say, hey, it's not like I'm going to walk down to my bank and say, hey, I want to invest in Vietnam. That's not usually how this goes. It's not like ordering a burrito bowl from Chipotle. This is a little bit more of a complex scenario.  

So when you want to invest in something like this, what are some ways that people can actually get access to emerging markets if they're not a sophisticated investor? 

Caleb Silver 

Yeah, that's a great question. And you're not going to go to your bank or your broker and say necessarily I want to invest in the country of Vietnam. There are ways to do that by buying the debt of Vietnam. If you want to buy government bonds issued by Vietnam, you can do that.  

But if you want to invest in the development of the country and the companies that are operating within that country, either if they're domiciled in Vietnam, let's just use that example or countries like a Microsoft that actually does business in Vietnam, that's the way to invest in that emerging market.  

And the vehicles for that, to get broad exposure, are index funds, right? These are baskets basically of companies that are put into a fund. They're weighted differently. The weighting of the companies is different throughout the fund. And the performance of that fund depends on the share price performance of the companies within it.  

Now similar to index funds, we have exchange traded funds. Your listeners might be aware of those. Again, these are baskets of companies, but they trade more frequently like a stock. They trade throughout the trading day versus an index fund which only gets one price, an NAV at the end of the day.  

So ETFs. Sometimes a little bit cheaper than index funds, certainly on the expense ratios. A little bit more accessible for retail investors. You can do the research on Interactive Brokers. You can do it on Investopedia. You can screen for emerging market funds and see what's in them and check their performance.  

Those are two ways to get exposure as an individual retail investor to emerging markets. Or like I said, if you want to invest in the country as a whole and its ability to grow its GDP, then you can think about buying some of the government bonds issued by that country. 

Cassidy Clement 

So there were a few different things there that you had mentioned as avenues of getting exposure to these emerging markets.  

But what are some questions that investors should ask themselves before just jumping into the pool for this? I'm sure that there are advantages and disadvantages when we're talking about places that are just starting to develop towards the economic culture that we're familiar with. There could be risks involved that most people don't even think of. 

Caleb Silver 

Yeah, geopolitical instability is the big one. You don't really know necessarily unless you've done the research what’s happening inside those countries. So you could be heavily invested in an emerging market or considering it, maybe there's a political coup, maybe trade relations breakdown between that country and its biggest trading partner.  

If you think about China as a good example, China and the US have a very tenuous trade relationship. It's getting even worse by the second. It's not a surprise that China, as a country, if you look at the index funds and the funds that invest in China and the businesses doing business there, those are some of the worst performers over the last three years.  

So there's the sensitivity to trade relations, geopolitical instability, but also, and this goes for anything that individual investors are considering investing in, you’ve got to know what you own.  

So you don't just buy an emerging market because you like the tick or like the sound of it. Look at what's inside of it.  

What are the constituents? What companies make up that index fund or exchange traded fund and how heavily are they weighted in those funds? Because their performance, ultimately, is what determines the performance of that investing vehicle, whether it be an index fund or an ETF. 

Cassidy Clement 

So even though users or we’ll say clients or investors, in this scenario, you might be investing in a fund, let's say that's in an American exchange. The exposure might be in another country. There's currency risk involved there, too, correct? 

Caleb Silver 

Yeah, and I'm glad to bring that up. Currency risk is another one of those big things you have to think about. What is the currency pairing relationship between that country and its biggest trading partners?  

So if you look inside a lot of these emerging market funds, the index funds and the ETFs, you're going to find a lot of companies you might be familiar with because half of the biggest companies in the United States do business overseas.  

Vietnam is a good example. You could take Poland, you could take South Africa. You're going to see a Microsoft, you're going to see a Nike doing big business in these countries. 

But the currency risk, the amount they make, the profit that they make is always subject to the currency translation that they have to do at the end of the day. So they may have a lot of operations, they may generate a lot of revenue, but if the currency is in in the favor of the company doing business, the results might not be that great.  

So look inside. Know what you own, know the exposure that those companies have, and then determine whether or not that's the appropriate fund or ETF for you. 

Cassidy Clement 

There were a few different things that you had mentioned throughout our conversation so far. Currency risk is one of them. The political landscape or government set up in these emerging markets.  

When it comes down to the US being a political power and impacting the economy, not only our own and around the world, how do some of these emerging markets change in terms of access and growth potential when it comes to policy changes, trade policy, election year time where there could be a change in the type of leadership and the view on certain markets or countries that we're doing business with privately? Or that you're investing in? 

Caleb Silver 

Yeah. Think about the United States and China. Another good example of that. We have tariff wars going on all the time, which impacts both countries on the import and the export side. You have bans of certain technologies. There's conversations around a TikTok ban here in the US. There's Huawei. A technology supplier that was on the banned list by the Federal Trade Commission and the US Treasury CFIUS. C-F-I-U-S. That's the department within the Treasury that is in charge of deciding whether or not countries and companies that are outside the US can sell things within the US, so you have all these things to consider.  

And definitely in an election year when China is one of the front and center issues for both candidates, you know that that country is going to be under the microscope. And there's going to be a lot of speculation about the future of business relations between these two global superpowers.  

But then take another country like an Argentina, right? It's an emerging market. It's a developed economy. It's got pretty strong exports. It's also gone through an incredible last decade of inflation. Now it has new leadership in President Milei.  

He's an interesting character. We don't know how relations between Argentina and the US are going to develop, especially after the November elections. You have to look at those political sensitivities. You have to look at the trade sensitivities and you have to look at whether or not business is going to be able to operate freely in a so-called efficient capital market manner when these things play out. 

Cassidy Clement 

Just out of curiosity, if you were to invest in one of these countries, let's say more so in the form of debt or a little more directly than, let's just say Microsoft is going to Brazil to open an office or something like that.  

When these types of policies go into place, if there's an issue with the relations, how exactly would you see it? Just an example of how the investor would see their investment get impacted. Would it be a lower return? Would it be a freeze? How exactly does that work? 

Caleb Silver 

Yeah. So let's look at Russia, for example. When Russia invaded Ukraine, a lot of US based companies decided to not do business there or close their franchises or sell their franchise.  

Well take a McDonald’s, for example. That has a lot of franchises all around the world. And in Russia, they go under a different name. I can't remember the name they used over there, but they're franchises. They pay a franchise fee.  

McDonald’s and other companies decided to sort of divorce themselves from those franchises, but how much revenue impact and profit impact does that have on the overall company? And in the case of McDonald's, not a lot, right? McDonald's does most of its business here in the US and in Europe. So Russia would be a relatively small market.  

You have to think about the impact of a company doing business inside these countries. What it's going to mean to their bottom line and the decisions those companies make, whether to continue operating there or whether they can operate freely and decide if that's going to be a material impact to the profit and then ultimately the share price.  

And companies are pretty smart about this. They deal with a lot of geopolitical risk. They're constantly thinking about how they operate outside the US.  
And not only that, inside the index funds or exchange traded funds, the people who manage these funds are constantly thinking about that sensitivity that companies have and then changing the weighting inside the fund of that company or even taking it out of the fund outright if it's doesn't look like it's going to be a material contributor towards the increase in the net asset value of the fund or the ETF. 

Cassidy Clement 

I mean this topic in particular is a “change every moment” type of thing because there's so many factors impacting not only the office in the US, but then the office or the franchise, as you mentioned, in other places throughout the world.  

And then the currency and then the marketing of it all, what the consumer trends are. There's so many moving pieces. So if listeners want to get more well versed or get more exposure to these concepts and know what to look for, or even how to enhance their research on emerging markets, what are some good resources or maybe some questions to ask themselves as they're putting together their research for a potential investment? 

Caleb Silver 

Yeah, let's start with that last part first. Why do you want exposure to emerging markets as an investor? And it's not a bad idea to have some exposure, but you also have to think about performance and you have to think about what future trends are telling us, right?  

So if you look at emerging markets around the world and I'm looking at some of the biggest exchange traded funds that have the most assets in them and how they've performed over time and it's not great. They're essentially flat for the year. Emerging market ETFs are essentially flat for the year. The S&P 500, as we're speaking, is up around 4 or 5%.  

But if you take it back even further in the past three years, they're down about 23%, while the S&P 500 is up about 150%. So if you're looking for performance, you're not necessarily finding it in emerging markets.  

That said, you might want some exposure because you might see some opportunity there, but know the geopolitical wind. Put your finger up. Know where the wind is blowing.  

And what we've seen over the last couple of years is sort of a deglobalization of the global economy because we’ve had COVID, we've had some dislocations, we have a bipolarization of politics happening all over the place.  

So that is a big trend that's going to be a mega trend over the next decade. What does that mean for these countries that are these emerging market countries and the companies that are operating within them?  

You have to be sensitive to that and decide whether you want exposure. You think there's opportunity or more risk going forward, so that's the big question you have to ask yourself. And how much exposure should you have as an investor and certainly shouldn't be the biggest part of your portfolio if you're here in the US. The US has been the place to invest and probably will be going forward, at least in terms of returns and dependability.  

So then there's that. So if you're looking for places to do that research, Investopedia.com is a great place to start just to get the background and foundational knowledge of what we're talking about when we talk about emerging markets.  

Also look at news at what's happening in these markets, but also you have a tremendous educational resource library on your sites, on your platforms. People can actually take index funds or ETFs, measure their performance, look inside of them and see the constituents. What makes up these funds. And are they funds that you want to be participating in as an investor.  

So it all starts with knowing what you own, but also knowing from a foundational perspective, what do we mean when we're talking about emerging markets? And they're not all the same.  

So you don't have to just invest in an ETF or index fund that covers all the emerging markets. You can be super specific. You can do North Pacific emerging markets; you can do emerging markets without China. You can do just Pac Rim. You can do South America. There is an ETF or index fund for basically any style or theme you want to approach. As an investor, you just have to do the research about where you want to put your money and where you think the best returns are and the lowest risk. 

Cassidy Clement 

So, really, at the root there, is what I hear pretty consistently when we go through different foundational concepts with investing, which is these, like everything else, pros and cons. 

But you have to do the research to weigh the opportunity to risk. And specifically with emerging markets, there is sometimes an info overload because there are so many facets to what can impact your investment. But usually you're not the first person to think about emerging markets as an opportunity.  

So there's a lot of research out there. There's a lot of places to learn, and there's different ways that you can invest. It’s not a one size fits all. So thanks so much for joining us again, Caleb.  

Caleb Silver 

My pleasure. 

Cassidy Clement 

So as always, listeners can learn more about an array of financial topics for free at www.interactivebrokers.com. Follow us on your favorite podcast network, and feel free to leave us a rating or review. Thanks for listening.