Last updated February 15th, 2019.
Investors seeking higher returns often choose emerging markets. Property and stocks in these countries have become a standard asset class for anyone seeking superior long-term gains.
The term “emerging markets” involves dozens of countries and every sector you could possibly imagine though. Generalizing all of them is impossible.
For example, Malaysia is on the verge of becoming a fully developed nation. They boast a GDP per capita of around $10,000 which is four times greater than the Philippines’. Yet both places still fall under the same vague “emerging market” umbrella.
Likewise, an Indonesian oil company has far different long-term potential and risk than a retail business in China. You can easily understand why emerging market investments vary widely in their performance and results.
These rapidly growing countries nonetheless enjoy some of the greatest opportunities on the whole planet. Here are the right (and wrong) ways to invest in emerging markets.
Don’t Invest in Emerging Markets ETFs
A few stock traders who have never even been to the developing world put out misinformation on the internet. I’ll try and help dispel some myths before telling you how to invest in emerging markets correctly.
One widespread piece of bad advice is that you should purchase ETFs (exchange traded funds) or mutual funds that focus on emerging markets. These assets are easily-tradable and the two easiest methods of investing in developing countries. But they’re also probably the worst ways.
There are several reasons why you should probably stay away from these funds. Perhaps most important is that they don’t actually invest in emerging economies.
Yes, you read that correctly. Lots of emerging market mutual funds and ETFs don’t even live up to their namesake and are blatantly misclassified. They consist largely of equities in developed markets.
The biggest such ETF in the world, iShares MSCI Emerging Markets (NYSEARCA:EEM), puts over 30% of its holdings in developed economies. Two out of the three top countries they invest in are South Korea and Taiwan.
Places like Qatar, the UAE, and the Netherlands are somehow on their list as well. By using any reasonable standards, those are all among the wealthiest nations on Earth and certainly aren’t emerging markets.
China also takes up more than 30% of the ETF’s holdings. There are now over $36 billion dollars in this fund even though half its total assets are invested in either developed nations or China.
Emerging market funds and ETFs remain convenient, especially if you’re a foreign investor, and are the most common ways people buy stocks in developing Asia. However, you should choose a different method if you truly want to invest in emerging markets.
You Should Buy Assets Directly: Here’s Why
If you shouldn’t buy mutual funds and ETFs, that leaves you with direct investment in emerging markets.
Moving somewhere like Cambodia and starting a company is often the best (and hardest) way to invest in high-growth economies. Buying up real estate in strategic locations may also lead to impressive gains over the long-term, giving you both rental income and appreciation.
But we’ll start off with the easiest way you can invest in emerging markets directly: purchasing individual stocks. Just to be clear, that’s in contrast to buying a basket of them through a mass-market fund or ETF.
You can purchase individual stocks in Asia, South America, and elsewhere without leaving your home because most brokers offer international trades. Charles Schwab and Fidelity, two of the largest American brokerage firms, allow trading in over a dozen countries.
Furthermore, a few emerging market stocks list themselves in countries other than where they are based. China Mobile, for one, is traded on both the New York Stock Exchange and in Hong Kong. Baidu is listed solely on the NASDAQ and you won’t find it on Chinese exchanges at all.
With that said, we think making international trades using a local account is much better. Your existing broker might let you trade in other countries. But you should still put forth some effort and open local brokerage accounts in the places you’re investing in.
The fee structure of a major U.S. broker. International trade commissions are as high as ten times the amount a locally-based brokerage would charge you.
That’s because brokers usually charge outrageous fees for international trades. As an example, US-based Charles Schwab charges HK$250 per trade if their clients want to buy or sell stocks in Hong Kong. Local firm Boom Securities charges HK$88 for the same trade.
Plus, buying shares of multi-billion dollar firms listed in New York negates most of the reasons why you should invest in emerging markets in the first place.
Stocks like Baidu have unattractive valuations, are over-analyzed by every bank on Wall Street, and aren’t the types of hidden gems which will make outsized returns.
Emerging Market Property and Direct Investment
Buying stocks is a solid way to invest in emerging markets if done correctly. Places like Vietnam and the Philippines have tons of undervalued small-cap stocks that see practically zero analyst coverage.
However, setting up your own business or purchasing real estate in those countries is often an even better choice.
The reasons are similar to why small-cap stocks in Vietnam have greater potential than China Mobile listed in New York. Easily-accessible markets are flooded with players such as Goldman Sachs and every other large institutional investor.
Hedge funds and banks spend billions of dollars on highly-paid analysts and complex software. These firms will buy stocks with any true, mathematically-proven value before you even realize the opportunity exists.
Morgan Stanley isn’t looking at apartments in Manila though. “Regular” investors can still find value in emerging market real estate before everyone else does.
Similarly, places like Cambodia lack basic business concepts that you might take for granted in your home country. There aren’t any drive-thru car washes, 7-Eleven convenience store chains, or major e-commerce players yet.
Entrepreneurs have lots of opportunities in emerging markets, and especially frontier markets, because of this.
We understand that not everyone can fly to Indonesia and spend time buying local property or starting a business.
Yet that’s part of the reason why these methods are profitable. Entry barriers keep institutional investors out and help maintain attractive valuations… you just need to break through them.
Another important thing to remember: not all emerging markets are growing quickly. Here are three of them that you should completely avoid.
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