Emerging Markets: A guide to investing in the drivers of global wealth

Highlights:

• There are several ways to take advantage of high growth rates and opportunities in emerging markets, your best bet to making the most of this is to invest in an emerging market fund.
• Distributing 4.25% in the last twelve months, the Calamatta Cuschieri Emerging Market Bond Fund aims to maximise the total return for investors by investing primarily in a well-diversified portfolio of fixed-income securities.
• Emerging markets, also known as emerging economies or developing countries are economies that are experiencing considerable economic growth, transitioning from being developing nations to developed.
• In order to determine whether a country is an emerging market, analysts employ a formula that uses a country’s gross domestic product (GDP) and per capita income. The so-called BRIC countries – Brazil, Russia, India and China – have long been examples of developing economies with explosive growth in the past decade.
• Emerging markets have a number of distinct characteristics that set them apart from developed countries. These include lower than average per capita income and swift economic growth. Others include market volatility due to political instability and external price movements, amongst other factors.
• These jurisdictions do pose risks such as political risk when the country has an unstable or volatile government, economic risk which can result from unregulated markets or unsound monetary policies, as well as currency risk since the value of emerging market currencies can be quite volatile.
• Having said that, as drivers of global wealth, investing in emerging markets can potentially offer returns at a faster pace. Other benefits include asset diversification due to the high level of exposure, while the potential for high growth is one of emerging markets’ greatest attributes and therefore for the appropriate clients wishing to diversify their investment portfolio such investments may be appropriate.
• Interested to explore the emerging world and invest in the drivers of global growth? Get in touch with us today to book an appointment with one of our professional investment advisors.

A phrase coined in the early 1980s to define investing in developing countries, emerging markets were once an obscure niche of international investing, so much so that as recently as 20 years ago, they made up less than 3% of world equity market capitalisation and 24% of GDP (gross domestic product).

Boasting great potential for growth and offering the possibility for great returns, these rapidly developing countries play an increasingly important role in the economic system. In fact, more than half of global economic growth is currently driven by these markets. Now considered mainstream investments, as the developing world continues to grow faster than the developed, the weightings of today’s emerging markets are likely to rise steadily, which in turn will grant them an essential position in global portfolios.

Below is a guide about the ins and outs of investing in emerging markets.

What is an emerging market?

Emerging markets, otherwise known as emerging economies or developing countries are economies that are experiencing considerable economic growth. They tend to invest in more productive capacity so that they can move away from their traditional economies that have relied on agriculture and the export of raw materials and industrialise, while they adopt a free market or mixed economy. In other words, emerging markets are countries that are transitioning from a developing phase to a developed one.

In order to determine whether a country is an emerging market, analysts employ a formula that uses a country’s GDP and per capita income. The so-called BRIC countries – Brazil, Russia, India and China – have long been examples of developing economies exhibiting explosive growth over the past decade. Emerging markets such as South Korea have a wealthy economy and a large number of consumers, whereas others, like the Middle East and Africa are still in the early stages of developing a strong economy.

What are the characteristics of emerging markets that set them apart?

Emerging markets have a number of distinct characteristics, which are as follows:

Lower-than-average per capital income

Emerging markets typically achieve a low-middle income per capita relative to other countries. The World Bank, in particular, defines developing countries as those with per capita income of $3,995 or less. In addition, lower average incomes function as incentives for higher economic growth. Emerging markets leaders are often willing to undertake this rapid change to a more industrialised economy in order to remain in power and to help their people. As the economy pursues industrialisation and other manufacturing activities, income per capita increases.

Swift economic growth

Governments of these markets often tend to implement policies that favour industrialization and rapid economic growth. These policies lead to lower unemployment, higher disposable income per capital and better infrastructure. In contrast, developed countries such as Germany or the U.S. experience low rates of economic growth due to early industrialization.

To put things into perspective, according to the IMF (International Monetary Fund) in 2019, the economic growth of developed countries like Japan, Germany or the U.S. stood at less than 3%, whereas growth of countries like India, Egypt and Malaysia was 4% or more and that of China and Vietnam was around 6% to 7%.

Potential for growth

When emerging markets transition from being an agricultural-based economy to a developed economy, they often need a lot of investment capital from foreign sources to feed both this transition and future growth due to a shortage of domestic capital. If successful, this rapid growth can lead to higher-than-average returns and this is what makes emerging markets attractive to foreign investors. In simple terms, there is a gap namely in terms capital investment when compared to the developed nations, while EM growth has a higher weighting on labour intensity.

Market volatility

Rapid social changes that take place in emerging markets, together with a range of other factors, such as political instability, external price movements and supply-demand shocks due to natural disasters can lead to high market volatility. For instance, economies that rely on agriculture can be especially vulnerable to disasters such as earthquakes, droughts and tsunamis. This can expose investors to the risks of exchange rates fluctuations, as well as that of market performance.

Currency swings

Emerging markets are more susceptible to volatile currency swings. For instance, when in 2008, the U.S. subsidised corn ethanol production, the move caused oil and food prices to increase and as a result, food riots ensued in several emerging market countries. Social unrest, rebellion or even regime change could lead to these governments defaulting on their debt or their industries becoming nationalised, which can affect investors.

What are the advantages of investing in the emerging markets?

As drivers of global wealth, investing in emerging markets can potentially offer returns at a faster pace. Here as some more benefits:

• Asset diversification: an important advantage of investing in emerging markets is the level of exposure offered which leads to further diversification, so that any economic downturns in one country or region can be offset by growth in another.
• Growth: the potential for high growth is one of emerging markets’ greatest attributes. Unlike developed countries that have already attained enough growth to create major economies, emerging markets are in the early stages of expansion and exhibit faster growth than that in developed economies.
• Valuation: while companies in developed markets have valuation factored into the price of their stock, those in emerging markets do not and this creates potential particularly for fund managers when it comes to identifying stocks that are trading at inexpensive valuations relative to their growth outlooks. Obviously other risk premia might also condition valuations on the downside.

What are the disadvantages of investing in emerging markets?

Emerging markets offer several opportunities, however, not all are good investments. Before you decide to invest in them, make sure that you opt for countries with little debt, a growing labour market and ideally, a government that is not corrupt. Below are some of the risks you may face:

• Political risk: emerging markets may have unstable or volatile governments. Political unrest can cause serious consequences to the economy and in extension to investors.
• Economic risk: insufficient labour and raw materials, high inflation or deflation, unregulated markets or unsound monetary policies can lead to problems.
• Currency risk: when compared to other currencies such as the dollar, the value of emerging market currencies can be quite volatile, so any investment gains can be reduced if a currency is devalued or drops significantly.
• Limitations in investment minimums: For those who can take exposure in direct emerging market instruments such as high yield bonds, the minimum batch sizes of purchase can at times make these attractive offerings a no go. Such clients then opt to invest in high yield emerging markets funds instead, as the fund itself will use the collective strength of its investors to purchase these instruments. In this manner, investors benefit from diversification, but without having to directly access these instruments.

How to invest in emerging markets

Although there are several ways to take advantage of high growth rates and opportunities in emerging markets, your best bet is to invest in an emerging market fund. Distributing 4.25% in the last twelve months, the Calamatta Cuschieri Emerging Market Bond Fund, aims to maximise the total return for investors by investing primarily in a well-diversified portfolio of fixed-income securities, particularly corporate or government bonds with maturities of 10 years or less. Ideal for those with a medium to high tolerance risk who are willing to hold on their investment for the medium to long-term, the fund makes the most of compound interest, while it also participates in the interest rate cycles that correspond with an investment in the emerging markets.

Traditionally, the BRIC nations are considered the quintessential emerging markets, with these alone accounting for roughly 30% of production globally, while they are known for offering good returns over time. The Calamatta Cuschieri Emerging Market Bond Fund’s top holdings include the BRIC countries, as well asMexico, Turkey and Oman.

China

The world’s most populous nation with over 1.4 billion individuals calling the country their home, China’s economy has posted an average growth rate of 10% since the enactment of trade liberalization and economic reforms in 1978, mainly due to government spending and expansion of its manufacturing sector and exports, particularly that of electronic equipment. Although China’s economy has been slowing down over the past couple of years, it, nevertheless, stands poised to become an even more dominant international player on the global stage as it aims to accelerate its technological development, stimulate private investment and create a bigger role for domestic consumption. Demographics will surely be a key factor in the medium term in fuelling premium growth when compared to developed economies.

Brazil

The largest economy in Latin America and a major driver of growth in the region, Brazil’s economy has been growing rapidly since the early 2010s at an approximate rate of 7.5%. The country has also experienced considerable improvements in income levels and poverty reduction, however, as of 2015, changes have been sluggish mainly due to lower economic activity, while due to political instability, trade sanctions and lower government expenditure, the country’s growth rate has also been slowing down. However, Brazil’s future outlook is positive with the economy expected to see sustained growth as government reforms attempt to cap public spending, boost infrastructure projects and reduce barriers to foreign investment. That said political instability remains an ongoing saga. However, nowadays emerging market investors have gotten accustomed to this norm and selectively uncover value in namely exporting credit stories.

Russia

The county’s shift from communism to capitalism coupled with the government’s default on much of its Soviet-era debt in 1998, a string of economic reforms and an export-oriented trade policy have all helped strengthen the country’s economy. As a result, Russia has undergone dramatic change. Driven primarily by oil exports which account for close to 52% of its exports, a global boom in commodities made the country’s stock market one of the world’s top performers until a downturn in 2015. Yet, the economy has been in recovery since 2017, experiencing a 1.5% growth in GDP, while in 2019 it grew at a rate of 1.7%. As geopolitical tensions with trade partners like the U.S., Canada, Japan and the EU diminish, economic recovery should be well underway despite the COVID-19 pandemic.

India

India established itself as an emerging market after trade liberalisation and other major economic reforms in 1991. In the past decade, the economy has grown at an average rate of 7.1%, with the exception of some fluctuations due to political stability and economic reforms. In particular, the country’s large English-speaking population together with a range of technology-savvy companies and workforce have been moulding India into a top emerging market. Indeed, the BSE Sensex index, a free-float market-weighted stock market index of 30 well-established and financially sound companies listed on the Bombay Stock Exchange, has come close to doubling since 2016, reflecting good growth and confidence by investors.

Emerging markets have made remarkable progress in strengthening their macroeconomic policies since the turn of the century, which has helped them more than double their per capita incomes on average. Many embraced major banking sector reforms and although progress was tempered by the global financial crisis in 2008, it was not entirely derailed.

Now, as the COVID-19 pandemic has entered its second year, concerns have been raised as to how well emerging markets have fared so far. But after a short-lived period of financial stress back in March of 2020, most emerging markets have been agile enough to respond to the economic fallout from the pandemic. Consequently, they were able to return to the global financial markets and issue new debt to meet their financing needs.

Interested to explore the emerging world and invest in the drivers of global growth? Get in touch with us today to book an appointment with one of our professional investment advisors.

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The Income Distribution Yield is an indication of the average income distributed by the Emerging Markets Bond Fund (“Fund”) over one year and is determined on the basis of the income yield generated and distributed by the Fund for the period from 1 October 2020 to 31 March 2021. The Income Distribution Yield of the Fund and the value of the investment may go down as well as up and past performance is not necessarily a reliable guide to future performance.

The CC Emerging Market Bond Fund is a sub fund of Calamatta Cuschieri Fund SICAV PLC and is licensed as a Collective Investment Scheme by the Malta Financial Services Authority under the Investment Services Act, qualifying as a ‘Maltese’ UCITS. Investment in the Fund should be based on the full details contained in the Prospectus, Key Investor Information Document (KIID) and the Offering supplement, which are available on www.ccfunds.com.mt or may be obtained from the below address. Initial subscription charges apply on investment in the Fund.

Approved for issue by Calamatta Cuschieri Investment Services Limited, Ewropa Business Centre, Triq Dun Karm, Birkirkara BKR 9034. Calamatta Cuschieri Invesment Services Limited (“CCIS”) is licensed to conduct Investment Services in Malta by the Malta Financial Services Authority under the Investment Services Act Cap. 370.