F.ORTY YEARS Antoine van Agtmael of the International Finance Corporation introduced the idea of a “Third World Equity Fund” to skeptical fund managers, and the concept of emerging markets found its way into global investing. The aim was to offer a diversified exposure in fast growing countries outside the rich world. Since then, emerging and developing countries have gained overall economic and corporate power. But the huge differences between them make it increasingly weird to put them all into a single category. What could a new framework for investments outside of the rich world look like?
In the early 1980s, emerging and developing countries made up about 25% of the world’s GDP, according to IMF. Today they make up about 40% and more than 20% of total global market capitalization. The market capitalization of the MSCI The emerging markets index, as a share of the global index, has risen 13-fold.
However, the economic situation of the countries is very different. For example, consider the MSCI Emerging market index. In 1988, when the meter was introduced, the per capita income of the countries included ranged from $ 1,123 in Thailand to $ 7,598 in Greece. In 2019, the range was more than four times that, ranging from India’s $ 2,100 to South Korea’s $ 31,846. The fortunes of some economies like Brazil and Russia are tied to the whims of the commodity markets; those in East and Southeast Asia, on the other hand, are driven by production.
Existing definitions of emerging markets do not capture this complexity. Most people, including many investors, think the category is tied to income level. Index providers are also considering whether trading in markets is as smooth as it is in the rich world. Although South Korea and Taiwan are prosperous, their markets are not considered “developed” as a result. The result is a highly concentrated grouping: the two East Asian countries together make up 27% of the MSCI Emerging market index.
Then how can you think about bringing more than three-quarters of the world’s population and two-fifths of the world’s economy in contact? A geographically structured framework appears only slightly less arbitrary than the emerging markets classification: the Turkish and Saudi Arabian markets, for example, have little in common. Another approach would be to segment countries by income. But even this can lead to strange results. The low-income category, for example, would combine places that haven’t evolved over decades with places that could soon rise. The Republic of the Congo and Vietnam have similar incomes per person, but share few other economic characteristics. Kuwait and Taiwan are broadly equally rich, but their stock markets are very different. Income levels alone do not say much about a country’s prospects.
Perhaps a more promising approach is to look at countries in terms of their growth models instead. This framework would apply to both the well-known large emerging markets and the more angular “frontier” markets. Investors who want greater exposure to export-oriented powerhouses could turn to not only China, South Korea, and Taiwan, but later adopters of the model like Bangladesh and Vietnam as well. These are still minnows compared to established companies’ market cap of around $ 16 trillion. However, it makes sense to add them as they could already benefit from rising Chinese wages and expand into technologically advanced manufacturing.
A second category could include countries that rely instead on service-oriented growth, with all the promise of healthy middle-class consumption. India and Indonesia are possible candidates here; Kenya could be a frontier market worth exploring. And a third group could include commodity exporters like Brazil, Russia and South Africa. These have brought dismal returns over the past decade and have contracted relative to emerging market indices. But climate change and the green transition could create new winners and losers as some resources like battery metals become coveted and others fall out of favor.
Such a taxonomy is far from perfect. Growth models can initially change over time. Just think of China, which is trying to become more consumer-oriented. Many smaller countries have long hoped to boost their exports but have been stumbled by poor policies. Nevertheless, the strategy of grouping a large part of the world’s population and production into one category no longer makes sense. Time to experiment.
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This article appeared in the Finance & Economics section of the print edition under the heading “Brave New World”