Emerging Markets: Worth Considering Despite Recent Volatility

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September 21, 2009

Scott Berg, portfolio manager of the Global Large-Cap Stock Fund, takes a look back at how emerging markets have fared and what he sees for the future.

Emerging markets have taken investors on a wild ride over the past two years. The MSCI Emerging Markets Index—a broad index of emerging markets equities—tumbled 62% from its peak in May 2008 to its trough in October 2008. Through August 31, 2009, the index then regained a large portion of its losses, rising more than 80% from its lows.

Swept Up in the Story

In many ways, emerging markets have been caught up in a storm not of their own making. The financial crisis in the developed world caused some investors to become extremely cautious and jettison emerging markets stocks alongside other historically risky assets—even though the banking systems in many emerging market nations remained in much better shape than those in Western Europe or the U.S. In addition, falling commodity prices also scared away many investors.

As Skies Clear, the Case for Emerging Markets Investing Remains Intact

While the global downturn appears to be moderating, the world economy has been changed indelibly by last year’s financial crisis. But the long-term factors driving the growth of emerging markets remain intact and offer some enduring arguments for investing in the sector.

Emerging markets contain the majority of the world’s most important economic resource—its workforce. At the start of the decade, the workforce in emerging markets was over three times the size of that in the developed world. This gap is expected to grow over the coming decades as the workforce in emerging markets expands dramatically while it contracts in developed nations.

Growing populations and economic development have helped consumption in emerging markets grow by 7% annually. This figure stands in sharp contrast to sluggish growth in developed markets.

Workers in emerging markets save and invest at much higher rates than citizens in most developed markets—putting aside roughly a third of their income. As a result, they may face fewer strains to pay down debt in the coming years.

Banks in emerging markets are also in better overall shape, with more room to expand lending.

Emerging markets governments have been able to respond aggressively to the global slowdown with stimulus packages due to their substantial foreign currency reserves, particularly in Asia. China, for example, has boosted infrastructure spending to help compensate for a decline in exports.

These factors mean emerging markets could account for two-thirds of world growth in coming years.

Part of a Diversified Portfolio

Emerging markets stocks are likely to remain especially volatile, and the outlook for the world economy remains uncertain. However, the long-term promise of emerging markets suggests that investors should consider them as part of a diversified portfolio.

Past performance cannot guarantee future results.

Sources: Bloomberg, World Bank, EIU, DataStream, Morgan Stanley Research, IMF, and World Economic Outlook Database.

Investments in emerging markets are subject to abrupt and severe price declines and should be regarded as speculative. The economic and political structures of developing nations, in most cases, do not compare favorably with the U.S. or other developed countries in terms of wealth and stability, and their financial markets often lack liquidity. Some countries also have legacies of hyperinflation, currency devaluations, and governmental interference in markets. Diversification cannot assure a profit or protect against loss in a declining market.