A note on the MSCI Emerging Markets Index
The MSCI Emerging Markets Indices cover over 2700 securities in 21 markets that are currently classified as EM countries. The EM equity universe spans large, mid and small cap securities and can be segmented across styles and sectors. MSCI regularly reviews the market classification of all countries included (or under consideration for inclusion) in its global equity universe based on extensive discussions with the investment community. Using the MSCI Market Classification Framework, MSCI examines each country’s economic development, size, liquidity and market accessibility in order to be classified in a given investment universe. Each June, MSCI communicates its conclusions on the list of countries under review and announces the new list of countries, if any, under review for potential market reclassification in the upcoming cycle.
Although many of the countries in the MSCI Index will be covered in detail, some were excluded based on concerns over their geopolitical situation, serious internal conflicts, small market, lack of transparency, or lack of access to investors.
For example, Saudi Arabia and Morocco were excluded because of their small market size and lack of reasonable access to foreign investors. Other countries that appear in some indexes but which have been excluded are: Argentina, Israel, Nigeria, Egypt, Pakistan, Vietnam and Myanmar, among others. In these cases these markets were excluded because of concerns about access or size, or political challenges. Broadly, all countries that are sometimes considered to be frontier markets were excluded (which includes some of the countries listed in the charts above).
Early-stage markets
In the first stage of development, investors discover the emerging market opportunity – be it a specific country, theme or sector. This stage is liquidity-driven and money flows are strong. In many cases, there is much promise and hype that in the end remains unfulfilled.
For example, from 2009 to 2010 many companies moved their manufacturing away from China to Vietnam based on its competitive wages. But Vietnam’s weak institutions, lack of skilled workers and crumbling infrastructure meant most shuffled their manufacturing back to China in the end.
There is potential for big profits investing in early-stage markets, but the timing for entry and exit must be impeccable. We will not be studying such early-phase markets in this book.
Mature-stage markets
Mature-stage markets are evaluated based on financial criteria such as:
Earnings and valuation
Cash flows
Return on investment
Debt levels
Longer-term growth
This book will examine mature-stage investments into countries and sectors that present longer-term improvements in fundamentals that are likely to reward investors.
Chapter 2: Reasons to Invest in Emerging Markets
This chapter establishes the main arguments for investing in emerging markets. It explores the factors that are likely to propel emerging market economies forward. It is doubtful that all countries stand to advance at the same rate, and some may not advance significantly from their current position, but the factors outlined here and the ten drivers of growth detailed in the next chapter reveal opportunities for many of these emerging countries.
Later chapters will examine individual countries in greater detail.
Key areas of development
Demographics
Between 1980 and 2010, the working age population in emerging markets increased from 1.6 billion to 3.2 billion. Simultaneously, the overall population of developed market countries increased from 713 million to 836 million. What’s even more striking is that these trends continue to strengthen in the emerging market countries. The youth populations of emerging market nations are on pace for further increases – without any significant migration patterns – while the developed world ages. The implications are obvious. As emerging markets continue to grow, so too will their share of global consumption.
Rising middle class
Middle class populations in most emerging markets are increasing dramatically. By the next decade the middle class in China will be more than 300 million (perhaps higher than the entire US population), with more than 200 million in India and millions more in Indonesia and Brazil.
Consistency of growth
Growth in emerging markets has, for the better part of two decades, consistently outpaced that of the developed markets. According to a recent report by the Economic Intelligence Unit (of The Economist magazine), for the next five years only China and India are projected to have economic growth rates above 7%, followed closely by Vietnam, Indonesia and Colombia. In comparison, all of the G7 nations are projected to have subpar growth around 2%. The World Bank has stated that since 2008 emerging markets have accounted for almost 70% of the global economic growth.
Better fiscal conditions
Many emerging markets are fiscally healthier than developed markets and have shown significant improvement over time. Looking at metrics such as the debt ratio, and in particular the foreign debt-to-GDP ratio, emerging markets seem to be in a much better position than many developed countries.
Better inflation targeting
Many, if not most, emerging markets are aware of the havoc runaway inflation can wreak on their economies and have taken that lesson to heart. Many of the countries have inflation targets with independent central banks as guardians.
Rising currency values
As economies grow and keep inflation under control, their currencies generally become stronger over time. This is a reflection of confidence in such growth being sustainable. This can provide investors with additional rewards.
Better banking systems
In the past emerging markets have suffered dramatic collapses because of failing banking systems that were over-leveraged with foreign denominated loans and non-performing assets, with insufficient regard for risk. The times have changed. The collapse of the 1990s banking system in Asia, Latin America and even Russia undeniably taught these countries a lesson that subpar banking systems can topple an economy and that international borrowers can be merciless.
The countries have therefore enforced strong discipline and the results are quite impressive. In the last recession of 2008 to 2009 – while the banks of developed countries were on the brink of failure, only to be rescued by the state – the emerging market countries had strong balance sheets, less leverage and much higher reserves.
Open trade
Many emerging market countries are WTO members.
