Countries such as China, India and Brazil that aspire to industrialize have economies that tend to grow faster than the U.S. and other leading industrialized nations. Increasing numbers of companies from these countries seek foreign investors by making shares available outside their home markets. These emerging market stocks can be rewarding investments, but they also come with considerable risk.
What is an emerging market stock?
Emerging market stocks are issued by companies in countries labeled as an emerging market. These economies are transitioning from a reliance on agriculture and natural resources to manufacturing and industry, and have financial markets that are still evolving. Their governments generally try to enact reforms and adopt financial regulations that would conform with standards in developed countries.
From an investor’s perspective, the main characteristics of emerging market stocks are the potential for greater returns, and greater risk of volatility. In other words, buying shares of a Chinese or Brazilian company may be more of a gamble than buying the shares of a blue-chip U.S. company.
Some emerging-market companies are well-known among U.S. and European investors. Examples include:
- Alibaba, the Chinese e-commerce giant, which trades on the New York Stock Exchange (NYSE). With a market cap of about $240 billion, it is bigger than all but the 25 largest companies in the S&P 500 Index.
- Infosys, an Indian provider of network systems consulting and information-technology services. It also trades on the NYSE, with a market cap about the same as General Electric and 3M Co. Infosys competes with IBM, Accenture and other leading office-network systems consultants.
- Banco Bradesco, a leading commercial and retail bank in Brazil and Latin America. It also trades on the NYSE.
- Grupo Televisa, a Mexican provider of cable and satellite television, telephone and Internet service in Latin America. After its recent merger with Univision, Televisa also is a leading provider of Spanish-language television programming in the U.S.
Considerations before buying emerging-market stocks
An investor in the U.S. might have several questions when considering purchasing an emerging-market stock, including:
1. What are the potential returns for EM stocks?
Because emerging-market economies generally grow faster than developed economies, stock returns can exceed those in the U.S., Europe, and other leading stock markets. In the decade ended December 2021, for example, average annual returns for EM stocks were about 5.5%, less than half the S&P 500 Index’s average of 13.8%.
2. How volatile are EM stock prices?
Emerging-market stock prices can swing more widely, and they can go through periods when they lag behind other benchmark returns.
3. Can I buy stocks from just one emerging-market country, or from all of them?
Yes, investors may choose to focus on a particular country’s companies—Chinese stocks, or Russian stocks, for example. Or they can buy funds that focus on groups of emerging-market countries, or regions, such as Asia-Pacific and Greater China including Hong Kong and Taiwan. An index fund tracking a benchmark such as the MSCI Emerging Markets Index includes companies from all countries.
4. Are EM stocks useful in diversifying my investment portfolio?
A wide mix of stocks across all emerging markets will provide more diversification than stocks from just one country, or just one emerging-market region. Mutual funds are one way to accomplish diversification. Index funds, including exchange-traded funds (ETFs), offer the widest emerging-markets diversification.
But investors should understand that composite indexes of emerging-market countries typically are dominated by China, because the size of its economy and stock market dwarfs other EM countries. Some funds have been created to exclude China, to allow other countries to have a more balanced weighting.
5. Do I need to exchange currencies to buy emerging-market stocks?
Exchanging dollars for local currency would be necessary if an investor is buying the shares through an exchange outside the U.S. But many emerging-market companies have shares that trade in dollars on the NYSE, Nasdaq, or over-the-counter (OTC) markets.
How to buy stocks of emerging market countries
Investing in emerging market stocks requires a few steps:
- Research. Investors can research recent performance of these markets, as well as review forecasts from economists. Some countries or regions may have stronger outlooks than others. Decide on an investment strategy: individual emerging-market stocks, or mutual funds or index funds.
- Set up a brokerage account. This will require depositing enough money to buy shares or a fund.
- Execute a buy order. This can be done through a trading app or a traditional broker. EM stocks typically trade as American depositary receipts (ADR) or American depositary shares (ADS), both of which represent the shares of overseas companies. More than 2,000 ADRs from more than 70 countries are listed on U.S. exchanges.
- Monitor the investment. Keep abreast of news and developments in emerging markets, including political and economic changes, that may affect the investment.
Potential benefits and risks of investing in emerging markets
Emerging-market stocks can offer some benefits to U.S. investors. They include:
- High returns. In 2009, for example, when markets began recovering from the 2008 financial crisis, the MSCI Index surged 78%, more than triple the S&P 500’s gain of 23%.
- Diversification. Investors can expand their holdings beyond the leading industrialized markets.
- Low correlation. Emerging market returns often don’t track U.S. and other developed markets, so if U.S. markets slump, emerging markets may do better.
At the same time, emerging market stocks carry risks, including:
- More volatility. Gains or losses can swing more than in the U.S. and other leading markets. Just as the 2009 performance of emerging markets surpassed that of U.S. stocks, the 2008 crisis resulted in a steeper decline: 53% for the benchmark MSCI index compared with 38% for the S&P 500. Greater volatility can result in lower long-term annualized returns.
- Less liquidity and price transparency. Emerging-market stocks may not be traded as easily as U.S. and European stocks, and their pricing may not be as clear and reliable, with possibly wider bid-ask spreads.
- Poor disclosure. Companies may not make timely and complete disclosures about important events, and financial statements may be unverified. For instance, some Chinese companies are giving up their U.S. stock listings because of a dispute with U.S. regulators about audit standards and the reliability of Chinese financial reports. Investors in Chinese securities also face the risk that the national government, which controls many enterprises, sometimes makes policy changes suddenly and unilaterally that could affect the outlook for these companies.
- Insufficient data. Historical company, industry and market data may not be as deep and thorough as data available in the U.S. and other advanced markets. This can make stock buying decisions more difficult for U.S. investors.
Key factors that affect an emerging market stock
Three key developments in recent years can affect the value of emerging-market stocks, including:
- The pandemic. Some emerging-market countries in mind-2022 still had varying degrees of COVID-19 restrictions on business, production and the labor force, and the emergence of new variants of the virus might prompt countries to maintain or revive restrictions, delaying a full economic recovery in these countries.
- Supply chain disruptions. The interruption of trade flows around the world mainly stemming from the COVID-19 crisis led to economic slowdowns and labor shortages. This meant reduced supplies of computer chips and auto parts from China and Taiwan, for example. And the Russia-Ukraine war resulted in a 50% drop in grain shipments from Ukraine, the world’s fourth-largest exporter.
- Geopolitical relations. Tension between emerging market countries, and with the U.S., can disrupt their economies, leading to big slumps in stock market values. The Russia-Ukraine conflict, and growing tension among China, Taiwan, and the U.S., are two examples. Russia’s MOEX stock market index declined about 40% through the first eight months of 2022, and Ukraine’s stock market has suspended operations. Benchmark indexes in China and Taiwan were down about 16% for the year as of August 2022. Other geopolitical tensions that could potentially disrupt emerging markets include India’s border and security disputes with Pakistan and Greece’s territorial disputes with Turkey in the Aegean and eastern Mediterranean.
The bottom line
Individual investors have many opportunities to buy stocks of emerging market companies, especially those that have U.S.-listed shares or are included in emerging-market stock funds and index funds. But investors can also have challenges in obtaining reliable information about emerging-market companies, and the market liquidity of shares of emerging-market companies can vary.