Based on their standard of living, the presence of an active stock market, and a significant level of free trade, countries can be classified under three categories: Developed markets, emerging/developing markets, and undeveloped markets. This blog post will discuss emerging market funds in particular.
The United States of America, Japan, Hong Kong, Canada, Singapore, Australia, New Zealand, and most of Western Europe belong to the developed markets league. Brazil, Russia, India, China, and South Africa, popularly referred to by their acronym BRICS, and other developing markets in Asia, Africa, and Latin America, are classified as emerging markets given their growth dynamics.
The rest of the countries in the world form undeveloped markets.
More about emerging market funds
Emerging market funds are mutual funds that invest in emerging markets. They aim to tap the growth potential of these progressively developing and expanding economies. Growth opportunities in developed markets have reached a saturation point. More people move to cities in emerging markets searching for jobs, resulting in increased consumption, spurring the growth of many new industrial sectors.
Investing in these countries is challenging. But it can be highly rewarding to investors willing to take risks. Some of the risks are:
- Political: A change of guard at the top could play spoilsport to carefully laid-out strategies. The change could be detrimental to the country’s development and to the emerging market fund’s portfolio. Geopolitical factors that could strain a country’s relationship with others could also impact your investments.
- Currency exchange fluctuations: A sudden change in the exchange rates of that country’s currency with the Indian rupee could affect the returns generated by the emerging market fund,
- Regulatory changes: Issues could crop up when the country ushers in regulatory changes that could harm investors.
How do emerging market mutual funds work?
They work more or less like domestic mutual funds but the portfolio investments will be in emerging markets and the rules of those economies will apply.
- Investment strategy: The fund house invests the monies in diversified instruments like shares and bonds of companies operating in emerging market countries.
- Fund manager: The fund manager, who has expertise in emerging markets, will have the authority to make investment decisions.
- Investment-types: Emerging market funds would invest not just in shares and bonds of firms operating in those countries, but also in exchange-traded-funds that focus on emerging markets.
- Risk and returns: Emerging market investments could be riskier as political and economic uncertainties can have a bearing on the portfolio. But the returns can be promising considering the growth potential of the economy.
- Fees and other charges: Fund-management fees and other related expenses will be deductible from the returns generated by the portfolio.
Who should invest in an emerging market fund?
All things considered, investments in emerging market funds will suit the following category of investors.
- Long-term investors: Emerging market investments may require patience and perseverance. Given the volatility and wild short-term fluctuations, one must stay invested longer to generate returns.
- Investors looking for diversification: Some investors prefer exposure to other markets and economies. Compared to developed market funds, volatility is higher in emerging market funds, but could fetch higher returns.
- Investors with a higher risk-tolerance level: Given the risks of investing in emerging markets, it doesn’t suit investors who have low risk-tolerance.
- Investors looking for growth opportunities: Most developed markets have reached a saturation point where many industrial sectors have little scope for further growth. However, emerging markets such as India show promise as the standard of living rises.
Factors to consider before investing in emerging market funds in India
Investing in emerging market funds in India opens up an opportunity for investors with a greater risk-appetite. However, you need to consider the following factors.
- One should be diligent about the economic and political stability of the country of investment.
- India has proved itself to be one of the world’s fastest growing economies since the 90s when our economy opened up.
- Inflation is an ever-present threat eroding the portfolio returns. The numeric value of the profits earned masks the purchasing power of the rupee when the rate of returns does not keep pace with inflationary trends.
- As an investor, you should be clear about the foreign investment regulations applicable in the emerging market. In some cases, exiting may not be as effortless as entry.
- The exchange rate risk is another factor you should consider. If the exchange rate is not favorable, portfolio gains get nullified when exchange rates are applied.
Emerging market funds offer a great investment opportunity. The returns may be enticing, but you must stay invested longer. The risks are high but may be worth the significant capital appreciation. Overall, it would be prudent to spread your investments across diverse asset-classes.