from General Electric to Google and Microsoft to Mitsubishi are racing to invest billions of dollars into creating new innovation centres in many of these countries. This is not likely to be a short-term phenomenon, but a process that is decades in the making. The path to growth in many emerging markets is likely to place less emphasis on politics than economics and less on ideology and more on opportunity. It is likely that many emerging market nations will be propelled to achieve in decades what took centuries in the past, given access to modern technological advances.
Today we live in a world where boundaries are blurred by the use of fibre optics and satellites. With these, many faraway areas and underdeveloped countries can bypass the multistage development of earlier years. For example, a country such as Botswana can completely bypass laying cable and landline infrastructures and leapfrog straight to cell towers, making world class communication cheaply available even to poor citizens. In another example, India is developing a state-of-the-art identification system using embedded information chips to protect the identities of its billion-strong population. The process is expected to be completed within a few years.
So, emerging markets are more defined by their trajectory than by their current circumstances, or more by their aspirations than by their accomplishments. Backers of emerging markets are watching and hoping that the progress in many of these countries can be sustained as their populations dream of a better future. Therein lies the promise of emerging countries.
Fortunately, this is a circumstance and an opportunity where most countries can win. The developed world gets what it wants: a large, new body of consumers with rising incomes and aspirations. Emerging countries get what they want too: vibrant economies, rising incomes and living standards, and likely avoidance of social upheaval.
Emerging markets – a bit of history
World Bank economist Antoine van Agtmael coined the term emerging market in the 1980s. He argued that although these countries suffered from governance and transparency issues, they represented above average growth rates as they were transitioning towards better economic and financial conditions. Agtmael published this thesis in his 1984 book, Emerging Securities Markets.
There were other early proponents of international and emerging markets, such as Sir John Templeton, who started international and emerging market mutual funds in the early 1980s. Templeton’s emerging markets mutual fund, run by the legendary Dr. Mark Mobius, is still actively traded today. In the early days, this was one of the few emerging market opportunities for ordinary investors.
In 1999, the first index of emerging markets (later acquired by Standard & Poor’s) was developed. As investing in these markets became more profitable, investors became interested – slowly at first, but with greater enthusiasm as years progressed. Firms such as Morgan Stanley and Goldman Sachs began using their vast market influence to secure investments for new funds dedicated to emerging markets, and Goldman Sachs garnered further interest by publishing their well-known papers: ‘Dreaming With BRICs’ in 1999 and ‘Building Better Global Economic BRICs’ in 2001.
This catchy acronym, BRIC, referred to four countries: Brazil, Russia, India and China. The overall theory was that these countries represented above average opportunities based on demographics, growing consumption, technological innovation and rising living standards. The timing for emerging market investing and the idea of BRICs was perfect as the recession and technology burst of 2000 had just ended.
Investors’ animal spirits were rising again. China, India and Brazil in particular were in the news for spectacular growth that exceeded that of the US and Europe by two-to-three times. At the time, Japan was still stumbling through its decades-long recession. Goldman Sachs created a special BRIC fund and BRIC50 fund, both of which became major hits with investors. The influx of capital to all four BRIC countries multiplied.
The great recession
This wave of economic growth and the stock market and real estate boom continued around most of the world (including the emerging countries) until late 2007. It all came crashing down in late 2008 and early 2009. The crash and the great recession that followed destroyed a large slice of wealth created during the boom years from 2003 to 2007. This recession created large tidal waves beyond the shores of America and Europe and in fact it hit the emerging markets even harder. Even though many of these emerging countries did not suffer economically or even record a recession, their stock markets lost substantial value.
However, stock markets also recovered faster in emerging markets. As an example, the stock markets in Brazil, India and China lost 41%, 52% and 65% respectively in 2008, and all of them gained over 80% in 2009. Russia was an outlier with a loss of 67% in 2008 and a gain of 121% in 2009.
Many people who had theorised that the emerging markets would continue to march to their own beat, unaffected by the developed markets, had egg on their faces. Despite good economic conditions and no recession, the shadow of the sluggish economies of the West (particularly in the US) loomed large over emerging markets. The theory of lack of correlation between developed world and emerging world (particularly in relation to stock markets), came under attack by investors.
If we move beyond the short-term performance of the stock markets, particularly at the time of global financial stress, there is a strong long-term case to be made for growth and opportunity in emerging markets. Long-term fundamentals of growth are in play for most of these countries – even though these will not be consistently reflected in the stock market gains.
The exhibit below presents a timeline of significant events in the recent history of emerging markets.
Exhibit – Timeline
How institutions perceive emerging markets
The semantic arguments for what constitutes an emerging market are not likely to end anytime soon. While investors should be mindful of this, it is far more beneficial to look at emerging markets the way that large institutions perceive them.
The following table covers almost every nation that is considered to fall into the category of emerging markets and shows which institutions regard these countries as emerging markets. A shaded cell indicates that the institution given at the column head regards the country in that row as an emerging market. As you can see, there is still some disagreement, but at least it provides investors with something approaching a concrete definition.
Exhibit – How financial institutions define emerging markets
Criteria for selection of the 18 markets
As of 2013 there were 193 countries recognized as members of the United Nations. At any point there are likely to be countries that represent a better case for investment than the rest. What criteria should define countries that can be considered to be ranked above average in investment terms?
The starting point for choosing the markets studied in this book was to take a framework of recognised market indexes such as MSCI Emerging Market Index. This index encompasses more countries than other indexes such as the Financial Times, S&P, and other lesser-known indexes. This index is populated by large, mid-sized
