The promise of higher returns, exciting growth potential, and fantastic bar stories, is enough to convince many of the need to get in on the action.
And why not with Emerging markets home to over 80% of the world's population1, accounting over 57% of the world's GDP2, but only representing 10% of the world's market capitalisation3, it offers a compelling investing option.
What investors also need to understand, however, is that emerging markets deliver higher returns because they are also inherently more risky investments and they are exciting because they are unpredictable.
Retail investors looking to jump on the emerging market bandwagon need to know exactly what they are getting into from the onset. On a positive note, they are better diversifying their funds and are investing in markets which have extremely lucrative growth potentials. On the flipside, they are taking on higher risks – including liquidity and forex risks; political and social unrest; a lack of transparency and ability to monitor their investments; and the list goes on.
While there are growing sentiments for investors to bypass portfolio managers4 altogether, in some instances, there could be good reasons to go with an experience and well-established one, especially when it comes to emerging markets. Here are a few reasons you should consider investing in emerging markets through a fund manager.
1. Less developed financial markets
In certain countries, the financial markets are not as developed as that of those in the United States of America or even Singapore.
Some emerging market economies may have lax corporate reporting requirements and a poor record for corporate transparency and disclosure. In other instances, economies such as Brunei, Angola and certain Central American countries do not even have stock exchanges of their own, and countries such as Ukraine, Cambodia and Myanmar have relatively young stock exchanges that do have much track record.
Unless an investor is willing to physically fly to a country, talk to companies, understand their financial statements, get friendly with people on the ground to gain insights into different industries, and then repeat for other such emerging economies, he or she has to rely on the expertise of portfolio managers to navigate such markets.
2. Portfolio managers have more opportunities to outperform in emerging markets
Mostly as a result of having less developed financial markets, portfolio managers have better opportunities to outperform in emerging markets. This is because information is king when it comes to investing, and in some emerging markets disclosure and/ or transparency may be lacking in public domains.
As the experts on the ground, portfolio managers will be in the country canvassing for unique and interesting investment opportunities. They will have better connections to people, better access to information and better grasp of how to best take advantage of the situation.
At the same time, they will be doing the legwork in getting to know companies, talking to their management teams trying to uncover more information that is not divulged to the public as well as speaking to industry insiders to gain further insights. No retail investor, even those who live in the same country, will have that kind of access or time.
Even for emerging economies that have indexes to track the country's best stocks, portfolio managers will have sufficient opportunities to outperform them for the same reasons above.
3. Economies of scale, diversification and transaction issues within emerging markets
It is reasonable for a retail investor to consider investing in many different companies given the volatility they can expect in emerging markets.
Foreign investors trying to invest in emerging markets may not be privy to local regulations for investments in the first place. Next, they have to consider opening foreign brokerage accounts, in more than one country if they are thinking of spreading their risks in different emerging economies. Even if investors buy stocks from exchanges that are supported by their brokerage house in Singapore, they will be subjected to a host of fees that may offset some of the fees that a fund will charge.
Funds will have numerous professional portfolio managers working for them on the ground picking the companies with the best potentials and will be invested in different companies within an economy or even industry. By pooling the monies of many investors, this provides individual investors the ability to tap on a fund's economies of scale to reduce costs and diversification functions.
There are good reasons to invest with portfolio managers, but investors need to weigh the risks and returns
Emerging markets offer compelling investment propositions as a viable option for diversifying one's portfolio as well as being able to offer lucrative returns. To potentially reap these rewards, investors need to understand that they are bearing higher risks as well. This may include political, economic and currency risks.
However, emerging markets might not be suitable for everyone as it is inherently more risky than other developed markets.