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Let’s Talk About Risk - Emerging Markets Versus Developed Markets

The vast majority of Canadian investors are under the impression that emerging markets are inherently riskier than developed markets. The underlying truth is that all markets, developed as well as emerging markets present some level of risk.

In the case of emerging markets, it is important to understand that this is not a homogeneous group of countries. Each market has its own unique growth drivers, and risks.

Emerging markets are perceived to be riskier than their developed counterparts for two primary reasons:

  • Risk is priced into emerging markets, whereas it is taken for granted by the domestic investor base in developed countries – which tends to have a home country bias. Canadian investors that allocate funds to the emerging markets are compensated for the level of risk they take with the possibility of greater returns; and
  • Emerging markets tend to experience greater price movements which lead to the perception of higher risk. However, greater variability in returns is not necessarily equal to higher risk.

The fundamental flaw in investor thinking is that they still view the world from a core-periphery standpoint, where developed markets are at the core and emerging markets are at the periphery and any market outside the core is automatically regarded as riskier.

This view is largely outdated as emerging markets have ‘grown up’ and are in fact the key drivers of global growth. In fact, almost 80% of global economic growth is driven by the emerging markets.1

In terms of market capitalization, emerging markets currently account for 11% of total global equity float and over 33% of total global market capitalization.2

Emerging markets also offer investors greater scope for diversification and consequently help towards risk reduction, when included in a broader portfolio, as there are significantly more emerging market nations than developed markets.

Additionally, despite their higher volatility, emerging markets have, on average, significantly outperformed developed markets over the long-term.

In conclusion, there are significant misperceptions about the challenges and rewards of investing in emerging markets. More often than not, the risks are overstated and it is more a question of variability in returns and investor tolerance for this volatility, as opposed to emerging markets being inherently riskier than developed markets.

To learn more, contact your financial advisor today.

 

1 IMF World Economic Outlook, 2016.
2 The World Bank, 2015.