Emerging markets are by definition Emerging small, but potentially dynamic and rapidly growing economies, where institutional investors and multinational corporations (MN Cs) can seek lucrative opportunities for medium to long/.term investments.
The World Bank defines an emerging market as one where GDP per capita income is below $8,000 per annum. Thus, in an absolute sense, markets do not come much more emerging than in Africa. But healthy emerging markets, with the exception of South Africa, are generally regarded as being in South America and South East Asian countries. Africa remains the poor relation.
Emerging markets (EMs) account for 80% of the world's population and over 20% of global exports. Their combined share of global stock market capitalisation is between 6-10%. The asset class is quite diverse with more than 50 markets spreading across five continents.
Some fund managers, however, tend to regard EM equities as bad investments because of their volatility, and at times, poor returns. These markets are, in fact, poor hedges against other equities because of their strong correlations with the US stock markets, especially the tech-weighted Nasdaq.
Some observers have classified EMs as high-risk assets - similar to corporate junk bonds lacking investment-grade status.
During the past decade, Morgan Stanley Capital International's emerging markets index has risen only 5% per annum in US dollar terms. In January-May 2001, weekly returns on Merrill Lynch's Emerging Market fund were 90% more volatile than those on the UK All-Shares index.
Are EMs danger zones?
The ongoing weaknesses of the New York, London, and Tokyo financial markets are not helping the investment case for EMs. Most investors having suffered hefty losses this year and are cautious of diverting their portfolios to less developed markets where credit-risks are obviously much higher.
Currency crises, like in Asia (late 1997) or the Russian devaluation of August 1998, can also inflict heavy damage on EM investors. The recent report by Washington-based Institute of International Finance (IIF) said: "A sharp and disorderly adjustment in exchange rates with the potential to disrupt markets and inhibit capital flows remains possible."
An additional operational risk of investing in EM, be it India or Zimbabwe, is capital controls, i.e. restrictions upon repatriation of interest, profits and dividends, as well as principal (original capital).
Barclays Bank comments: "Zimbabwe is the classic case of an EM going from delivering excellent performance over a short period of time to one where investors experience extreme problems in getting both sale proceeds and income out of the country due to dire shortage of hard currency.
There are very few global multinationals in the EM universe, their activities extending to automobiles, pharmaceutical, telecommunications and information technology sectors.
Most EMs' leading companies specialise in cyclical businesses, such as resources (mining, oil & gas), household goods, construction/building materials and textiles. The performance of a cyclical stock is mainly driven by general economic conditions.
Analysts at Old Mutual Asset Managers argue that the cyclical nature of trading makes it difficult to generate adequate and consistent returns on investments.
Furthermore, interest rates are …