Emerging markets are popular investments for many investors.

Why?

Emerging market investments may aid in reducing portfolio risk through enhanced diversification. At the same time, there is also the potential for higher returns in less developed markets.

Today we look at what constitutes an emerging market. 

Emerging markets are often seen as high flying investments in uncontrolled regulatory environments. Growth oriented assets with high price to earnings ratios. Located in far flung corners of the world, a long distance from your developed and well regulated domestic market.

But this is not necessarily true in all cases.

What is an Emerging Market?

Per Investopedia, an emerging market economy:

is defined as an economy with low to middle per capita income. Such countries constitute approximately 80% of the global population, and represent about 20% of the world’s economies.

… countries that fall into this category, varying from very big to very small, are usually considered emerging because of their developments and reforms.

… are characterized as transitional, meaning they are in the process of moving from a closed economy to an open market economy while building accountability within the system.

Because their markets are in transition and hence not stable, emerging markets offer an opportunity to investors who are looking to add some risk to their portfolios.

That is the financial world’s agreement on what constitutes an emerging market. Countries with lower per capita income and wealth. However, the size of the country’s economy can be big or small, which may surprise some investors.

The key aspect is that the country is in a financial transition. Moving from an unregulated, disorganized system towards one with better oversight, transparency, and rule of law. Things that give investors some confidence and therefore begin to attract domestic and foreign investment.

However, because the shift to full development is not complete and there is some probability of regression, investing in emerging markets is riskier than investing in a developed market. And with greater risk, there is the expectation of higher returns.

This, plus diversification benefits, is a major reason why investors take a chance on emerging markets.

Who are the Emerging Market Countries?

Anyone that meets the criteria above. You can make your own determination.

But in many financial instruments, an emerging market country is more closely defined. And some of the inclusions may not appear to many readers as emerging markets.

For example, the MSCI Emerging Markets Index currently includes only 21 countries in their index. As at May 30, 2011, the index only included:

Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

Brazil, China, India, and Russia have substantial economies, yet they are still considered emerging markets. That said, these countries are also often segregated into their own fund, known as BRICs.

Frontier Markets

And where are countries such as Kenya, Lebanon, and the Ukraine? Are they not also emerging markets?

Yes. But they tend not to be included in emerging market indices or funds. Instead they are classified as “frontier markets”, reflecting even less development.

As at May 30, 2011, the MSCI Frontier Markets Index includes 25 countries, with a few more under consideration.

Argentina, Bahrain, Bangladesh, Bulgaria, Croatia, Estonia, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Nigeria, Oman, Pakistan, Qatar, Romania, Serbia, Slovenia, Sri Lanka, Tunisia, Ukraine, United Arab Emirates, and Vietnam. The MSCI Saudi Arabia Index is currently not included in the MSCI Frontier Markets Index but is part of the MSCI Gulf Cooperation Council (GCC) Countries Index. The MSCI Bosnia Herzegovina Index, the MSCI Botswana Index, the MSCI Ghana Index, the MSCI Jamaica Index, MSCI Trinidad  & Tobago and the MSCI Zimbabwe Index are currently stand-alone country indices and are not included in the MSCI Frontier Markets Index. The addition of these country indices to the MSCI Frontier Markets Index is under consideration.

Know What You Are Investing In

A wide range of countries are considered emerging markets.

In some cases, the term “emerging market” may not seem appropriate for some of these countries. India, Brazil, China, and Russia may come to mind. All have large economies and close ties to many developed nations.

And in some cases, countries that are really emerging markets are not classified as such. Argentina, Croatia, Estonia, Lithuania, the Ukraine, and Vietnam are emerging markets, but categorized as frontier markets. And countries such as Ghana, Jamaica, and Saudi Arabia are neither currently classified as emerging or frontier markets.

When assessing potential investments, do not assume that an emerging market investment falls under a common sense perspective. You need to dig a little deeper to really know what you are investing in.

That way, you will be able to build a more effective and efficient investment portfolio.

Next a look at the potential advantages of adding emerging market assets to your portfolio.


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