Investors have a few ways to play emerging markets, but investing by directly purchasing individuals securities generally isn’t one of them. Most brokerages don’t provide access to these often-volatile and illiquid stock and bond markets, which leaves investors with the following options:
Mutual funds: Actively managed mutual funds are often the best way to get direct access into emerging markets. The reason being expertise and knowledge do truly offer an advantage in these markets, which are considered very inefficient, meaning pricing often does not reflect the true value of publicly traded firms listed on the markets. The one drawback to mutual funds is their management cost. To get the expert advice, you often have to pay a management expense ratio (MER) higher than 2.5 per cent, which can act as a major drag on performance, says investment adviser Uri Kraut.
Exchange traded funds: ETFs offer diversified, low-cost exposure to a variety of emerging markets. That’s the upside. The main drawback is ETFs are often built on the market capitalization of the underlying investments, so the larger the company, the larger its weighting is in the fund. This “means you’re often getting yesterday’s story,” Kraut says. “So the emerging market ETFs could be mostly a collection of the stocks that did well in the last cycle and that may not be where you want to be for the next one.”
Buy the developed market: Investing in U.S. and Canadian firms with exposure to emerging markets is a common strategy for investors who are uncomfortable with the risks of owning emerging market assets through funds. Kraut says investors can invest in blue-chip U.S. companies such as Coca-Cola increasingly focused on expanding sales into emerging markets. Still, this strategy has limits, says Christine Tan, a portfolio manager with Excel Funds. “When the average income first gets beyond the survival level, the first thing consumers will seek are western brands,” she says. “But as income levels grow, you’re starting to see local companies that are better able to address the very specific local tastes and preferences become larger players.”
What about Canada? A few years ago, Canada’s stock market — with its ample energy and mining firms — offered a good way to get exposure to emerging markets, particularly China with its seemingly unquenchable thirst for natural resources. But that has fallen off as China’s economy has become more consumer-focused. Demand for commodities will continue, particularly oil as more consumers buy cars. “But it’s all about the quantum,” Tan says. “It will take a lot of little EM countries to make up for that (China’s demand slackening), and that’s why I don’t think it’s (the Canadian market) the same as it used to be.”
What’s an emerging market? These are developing markets with low to middle per capita income. They have fast-growing economies and generally large populations. They are diverse, crossing many geographies and sizes, but they all share the characteristic of undergoing significant reform and social change. The more notable ones are China, India, Russia, Brazil and Indonesia. There’s also a subcategory of emerging markets called ‘frontier markets’. These include Ukraine, Jordan, Kazakhstan, Vietnam, Botswana and Bulgaria, to name just a handful of thr few dozen in this sector. Frontier markets are considered investible as they have ‘functioning’ stock markets, for example, only less mature than and even more volatile than more well-known emerging markets.