Among the biggest challenges facing investors today is generating growth while managing market volatility and low interest rates. Achieving these goals can be daunting, given the issues confronting economies around the globe in recent years. Investors who are looking for diversification and growth in this environment may want to consider adding emerging markets to their investment mix. In general, this asset class may make sense for investors who are willing to accept some risk, and who have an investment time horizon of five or more years. Here is what investors should know as they evaluate if emerging markets should have a role in their portfolio.
Nations on the rise
Countries with the “emerging market” label are still gaining a foothold in the global economy. Their publicly-traded debt and equity markets may be relatively young. They may represent countries of various sizes, from relatively small economies like Peru and the United Arab Emirates to some of the largest countries in the world such as China, India and Brazil.
In search of higher returns
Emerging market stocks have the potential to generate more rapid growth than stocks from developed markets, such as the U.S., Japan or Germany, which tends to attract investors focused on accumulating wealth. These markets typically experience more rapid economic development than established countries. This may lead to new industries, more jobs and a growing middle class of consumers. As a result, emerging market companies often have opportunities to expand businesses more rapidly. This potential offers a unique opportunity for investors who are focused on growth.
And they aren’t limited to stocks. Investors seeking diversification in a bond portfolio can also invest in emerging market debt. The benefits of doing so may vary, although in some cases, these bonds may pay higher yields than what investors are accustomed to receiving from more established bond issuers.
Investing in emerging markets can play an important role in more effectively diversifying a portfolio. The performance of these stocks and bonds often varies from that of developed markets around the globe. Having a well-diversified portfolio, which may include emerging markets, can help smooth out short-term investment performance.
Taking proper precautions
While recognizing the growth and diversification opportunities created by emerging markets, investors need to be prepared for another reality. These stocks and bonds can be subject to more fluctuation in value than other types of investments.
As a result of this added risk and potential volatility, it’s important that investors utilize emerging market investments in a prudent manner. For example, 2015 was a year when stock markets in the U.S. and other developed markets were relatively flat. By contrast, emerging market stocks as a whole declined in value by more than 14 percent (based on the MSCI Emerging Market Index), a good example of how unpredictable market performance can be in this part of the investment world.
This level of volatility is due to a variety of factors. One of them is that markets and economies in many of these countries are not well established. The regulatory environment can be unproven and subject to change. Companies may face more challenges building and maintaining business, while governments can sometimes encounter instability. These and other factors contribute to uncertainty surrounding emerging market investments.
Yet the opportunity is clear. Emerging markets may be positioned to provide significant growth in the global economy and investors focused on building wealth or increasing diversification may want to consider adding this asset class to their portfolio. But it bears repeating, for most people, these stocks and bonds should only represent a modest position in a portfolio given the volatile nature of these asset classes. Discuss the potential with your financial professional before you make any investment decisions.