The Dangers of Investing In Emerging Markets

Singapore’s right smack in the middle of an Asian region where many emerging markets are in a potentially exciting time for growth.

China’s gross domestic product (GDP) has expanded at an annual clip of 15% between 1992 and 2013 and although the Asian giant’s recent growth figures have come in ‘only’ at the high single-digit level, these are still tremendous numbers for a country that recently overtook the U.S.A as the world’s largest economy.

Meanwhile, new political leaders in India and Indonesia have driven up hopes that these two populous countries could finally live up to their potential. Even Myanmar, which only started opening its doors to foreign investment a few years ago, holds promise of great growth given that its economy is roughly one-twentieth that of South Korea’s despite both having a similar population size.

Given Singapore’s geographical proximity to these places, as mentioned earlier, it’s easy for investors to get attracted to these emerging markets. And, I was recently reminded of this temptation.

Staying close to growth

A few days ago, I was out having lunch with a friend of mine who works in the financial advisory industry. Over the course of our meal, she shared that a friend of hers had recently invested in several China and India funds through a financial adviser – and apparently, the same financial adviser was also heavily pushing the same funds to other clients.

Without me speculating on the adviser’s motivations behind the push, it still seems very likely that a part of the reason would be due to the strong economic growth expected of both countries. In an October 2014 report, the International Monetary Fund had forecasted that China and India’s GDP would increase by 7.1% and 6.4%, respectively, in 2015. For some perspective, Singapore’s economy is expected to expand by only 3.0% next year.

There’s nothing wrong with wanting to invest in fast-growing regions. But if the adviser’s investing thesis for the China and India funds had rested solely on how fast both countries are expected to grow, then a word of caution is terribly needed.

How growth and returns can be uncoupled

That’s because as counter-intuitive as it may be, GDP growth can sometimes be completely uncorrelated to a country’s stock market return. The tweet below, from investment manager Ben Carlson, shows it clearly:

So China, with its mighty GDP growth, saw its stock market become a massive disaster of an investment over a two-decade period. Meanwhile we have Mexico, with GDP growth that can be described as anemic at best, posting some heroic long-term returns for stock market investors.

Lest you think this is merely a fluke result, I’d let finance research outfit MSCI Barra Research’s May 2010 paper show you why it’s not. The paper, titled Is There a Link Between GDP Growth and Equity Returns, wrote that “the correlation between stock returns and economic growth across countries can be negative.” This is a chart from the paper showing how that is so:

Graph of stock market returns and GDP growth rates

Equating a fast-growing nation with a fast-growing stock market is a classic case of single-variable analysis and it can be a very dangerous thing for investors to do. As investor Howard Marks once said:

“One thing you can never be sure of in the investment world is <<if A, then B>>. Processes and linkages are not always predictable.”

Right now, Singaporean investors who want a slice of the pie from emerging markets in Asia may do so easily in Singapore’s stock market through country-specific exchange-traded funds (ETFs) or even through individual shares that do business predominantly in that country.

A Fool’s take

For instance, investors seeking exposure to India can do so through the iShares MSCI India Index ETF (SGX: QK9) and Ascendas India Trust (SGX: CY6U); the former’s an ETF tracking the MSCI India index while the latter is a business trust which owns business parks in India. For Myanmar, there’s Yoma Strategic Holdings Ltd (SGX: Z59) a mini-conglomerate involved with real estate, agriculture, construction, tourism, retail, and the automobile markets in the country. And for Indonesia, there’s the Lyxor ETF MSCI Indonesia (SGX: P2Q), an ETF tracking the MSCI Indonesia Net Total Return Index, and Jardine Cycle & Carriage Limited (SGX: C07), Indonesia’s largest auto distributor.

These ETFs and shares might all become great investments. Or they may not. But if you’re looking at them only because they’re tracking the stock markets of fast-growing economies or because they’re engaged in business activities there, that might be a dangerous thing to do.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.