Emerging Markets for International Capital Investments

Of late emerging markets have become a buzzword among the  international investors for reaping greatest potential rewards which would be  impossible if they stayed put in their affluent hinterlands. The term emerging  markets (EMs) is a collective reference to the stock markets of the developing  nations.  A question, which overpowers a discerning mind, is why the  international investors are looking towards emerging markets for investing  their funds instead of established markets like US? Three reasons can be  given to answer this question.

Emerging markets for international investment opportunities

First, the average total return of emerging  markets  has outstripped those of  developed markets. Investments total return index computed by the IFC (International Finance Corporation)  which  measures the total return for each country based on those stock available to  foreign investors shows that return on investment in IFC composite of EMs is  61.64 per cent higher than the return on investment in US market over the  years. The institutional investors like the corporate pension funds; insurance  companies and international mutual funds are looking towards investments in EMs to magnify their earnings.

Secondly the emerging markets provide excellent scope for  diversification, as their correlation with the US and other developed markets is  often exceptionally low. The EMs has low correlations not only with the  developed markets, but also with each other. The fact that EMs (individually  and as a group) has low correlations with the developed markets implies that  there is an opportunity for diversification for the global investor.

Thirdly as  the emerging  markets  are generally inefficient markets, the opportunity of finding bargain  stocks increase for the highly knowledgeable money managers.  It is comparatively easier to beat the markets in the EMs as compared  to developed markets. In developed markets more arcane ones with mixed  results have supplemented the traditional tools of Fundamental Analysis and Technical  Analysis. For example, there are computer programmes called Neural  Networks, which seek to identify underlying general patterns in share price  movements to obtain clues about future prices. The evidence so for is  inconclusive. The problem may be that such tools are quickly adopted by a  large number of players so that they soon become history. In such a situation  the investors are attracted by what they consider to be the relatively inefficient  markets of developing countries. Perhaps their tools of analysis will yield  good results there.

Fall in the real interest rates in US coupled with a strong  growth in the developing world spurred on the demand for emerging market  equities which pushed market beyond their fundamental values.

Considered on the risk from EMs are extremely risky when compared  with developed markets. Apart from the obvious threats (political instability,  insider trading and others), there are a number of possible reasons why these  markets are extremely volatile. First they tend to be fairly concentrated; the  larger stocks have a high proportion of the overall capitalization. As a result,  there are fewer opportunities for diversification, and returns of these stocks  dominate overall market return. Second, unlike the developed markets, which  tend to have forces that affect diverse sectors of the economy differently, the  EMs tend to have a strong market related force that affects all stocks within a  market. This widespread effect tends to accelerate volatility.  It is true that emerging markets are extremely risky taken  individually, but considered together EMs provide a good scope for  diversification as these markets have low correlations not only with each  other, but also with the developed markets. It is a generally accepted fact that  investment in unrelated markets reduces the degree of risk.

Credit: International Finance-CU

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