Emerging Markets: What You Should Know

With the US stock market hanging around all-time highs, and with the nagging prospect of at least slightly higher interest rates, many investors are wondering how much more upside can be expected from domestic stocks. Others are eyeing overseas markets–particularly those in rapidly developing parts of the world–and considering whether the pastures might be greener on the other side of the ocean.

While we generally urge investors to take a long-term view of investments in any market, whether domestic or foreign, it might be worthwhile to think about the special characteristics of investing in emerging markets–places like Malaysia, Thailand, the Czech Republic, Turkey, Hungary, and, to a lesser extent, China and South Korea. What are the rewards of investing in places like these, where growth patterns are associated with relatively new, rapidly expanding economies? And what are the dangers?

First of all, many analysts see tremendous upside potential in emerging world economies and the markets associated with them. The MSCI Emerging Markets Index is up 25 percent over the last twelve months or so, compared with an increase of 15 percent for the S&P 500 during the same period. (Note: The MSCI Emerging Markets Index has also underperformed the S&P 500 over stretches of time in the recent past.) Further, in recent times, emerging markets have seen relatively low volatility, which has been attractive to a number of large investors. Many analysts believe that overall valuations are not stretched nearly as thin for companies in the emerging markets as they are for more mature companies in the United States. And these characteristics carry over into more than just stock investments; many of the emerging market countries are also sources of good yields on bonds and other interest-bearing investments, as companies experiencing rapid growth bid up the cost for the borrowed funds they need to fuel their expansion.

But what about the risks? Certainly, any investment in an emerging market–or any foreign security, for that matter–is subject to at least one risk that is not present in domestic investing: currency risk. In other words, when a security is purchased in US dollars, its value can fluctuate, not only according to the underlying value of the company, but also according to the value of its home currency in relation to the US dollar. And there are other risks, as well. Transaction costs for buying and selling foreign securities can be quite high, so investors should thoroughly discuss and understand these before making any commitment. Liquidity is also a consideration, since trading in foreign investments are subject to the limitations of the specific markets. Political, financial, or even military turmoil in a foreign country can sometimes obstruct the markets for their securities, and thus hamper an investor who wants to buy or sell.

For any investment you are considering, of course, it is always best to have a careful discussion with a financial advisor who is familiar with your situation, your risk tolerance, and your overall portfolio. Emerging market investments can be an important part of your overall financial strategy–as long as you know all the facts.

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