Emerging Markets Investing: Risks, Rewards, and How to Get Started

Emerging markets represent some of the fastest-growing economies in the world — countries where rapid industrialization, urbanization, and rising middle classes create investment opportunities that simply do not exist in developed markets. Yet for many investors, emerging markets remain an afterthought in their portfolio, or a source of anxiety due to perceived risks. Understanding both the potential and the pitfalls is essential for making informed allocation decisions.

What Are Emerging Markets?

Emerging markets (EM) are countries with economies that are transitioning from lower-income, less-developed status toward becoming advanced, developed economies. They are characterized by rapid economic growth, increasing integration with global financial markets, and developing institutional and regulatory frameworks.

The major index provider MSCI classifies 24 countries as emerging markets. These are distinct from developed markets (like the U.S., Japan, and Western Europe) and frontier markets (even less developed economies like Vietnam and Nigeria).

Key Emerging Market Countries

• China — The largest EM by market capitalization, with the world's second-largest economy. Represents roughly 25-30% of most EM indices.
• India — One of the fastest-growing major economies, with a massive young population and a rapidly expanding technology sector.
• Taiwan — Home to Taiwan Semiconductor (TSMC), a critical company in the global tech supply chain. Heavily weighted in EM indices.
• South Korea — Advanced technology sector anchored by Samsung and other global brands. Some indices classify Korea as developed rather than emerging.
• Brazil — The largest economy in Latin America, rich in natural resources and agriculture.
• Other major EM countries — Mexico, Indonesia, Saudi Arabia, South Africa, Thailand, and Poland round out the top holdings in most EM funds.

Why Include Emerging Markets in Your Portfolio

Diversification

Emerging market stocks do not move in perfect lockstep with U.S. stocks. While correlations have increased over time due to globalization, EM still provides meaningful diversification benefit. Different economic drivers — commodity prices, local monetary policy, demographic trends — create return patterns that differ from the S&P 500.

Growth Potential

Emerging markets account for roughly 40% of global GDP but only about 12% of global stock market capitalization. This gap suggests that as EM economies continue to develop and their financial markets mature, their share of global market cap should grow. The demographics are compelling: EM countries are home to 85% of the world's population, with younger average ages and faster population growth than developed nations.

Valuation Opportunity

Emerging market stocks have historically traded at lower valuations than U.S. stocks. As of recent years, the price-to-earnings ratio of EM indices has been roughly 30-40% below that of the S&P 500. While lower valuations reflect genuine risks, they also mean more potential upside if those risks do not fully materialize.

Currency Diversification

Investing in EM provides exposure to non-dollar currencies. While currency fluctuations add short-term volatility, over the long term, currency diversification can be beneficial — especially if the U.S. dollar weakens from its historically strong levels.

The Risks of Emerging Markets

Higher expected returns come with higher risks. Honestly assessing these risks is crucial before investing:

Currency Risk

Emerging market currencies can be highly volatile. When an EM currency depreciates against the dollar, it reduces the dollar-denominated return for U.S. investors — even if the local stock market performed well. Currency crises (like the 1997 Asian financial crisis or the 2018 Turkish lira collapse) can cause severe, sudden losses.

Political and Regulatory Risk

Many EM countries have less stable political systems, weaker rule of law, and greater government intervention in markets. China's crackdown on its technology sector in 2021 wiped hundreds of billions of dollars from investor wealth. Nationalization of industries, capital controls, and sudden policy changes are all real risks that are largely absent in developed markets.

Liquidity Risk

Many EM stocks trade with lower daily volume than their developed market counterparts. This means wider bid-ask spreads and greater price impact when buying or selling, which can increase costs and make it harder to exit positions during market stress.

Corporate Governance

Accounting standards, minority shareholder protections, and corporate transparency are often weaker in emerging markets. This increases the risk of fraud, related-party transactions, and other governance failures that can destroy shareholder value.

Concentration Risk

EM indices are heavily concentrated in a few countries and sectors. China and Taiwan together can represent 40-50% of a broad EM index. The technology and financial sectors dominate. This means a "diversified" EM fund may be less diversified than it appears.

How to Invest in Emerging Markets

Broad Emerging Market ETFs

For most investors, a broad EM exchange-traded fund is the simplest and most cost-effective approach. These funds hold hundreds of stocks across all major EM countries, providing instant diversification.

• Vanguard FTSE Emerging Markets (VWO) — One of the largest and cheapest EM ETFs, with an expense ratio of 0.08%. Uses the FTSE index, which includes China A-shares but excludes South Korea.
• iShares Core MSCI Emerging Markets (IEMG) — Tracks the MSCI index, which includes South Korea. Expense ratio of 0.09%. Broadest country coverage.
• Schwab Emerging Markets Equity (SCHE) — Low-cost alternative at 0.11% expense ratio.

Country-Specific ETFs

If you have a strong view on a particular country, single-country ETFs allow targeted exposure:

• iShares MSCI India (INDA) — Pure play on India's growth story
• iShares MSCI Brazil (EWZ) — Exposure to Latin America's largest economy
• KraneShares CSI China Internet (KWEB) — Focused on China's tech sector

Country-specific investing carries substantially more risk than broad EM exposure. A single policy decision, economic crisis, or geopolitical event can cause severe losses in one country that would be diluted in a diversified fund.

Ex-China EM ETFs

Given China's dominant weight in EM indices and its unique political risks, some investors prefer to separate their China exposure. ETFs like the iShares MSCI EM ex-China (EMXC) give you broad EM exposure without China, allowing you to control your China allocation independently.

EM Bond Funds

Emerging market bonds offer higher yields than developed market bonds, reflecting higher credit and currency risk. Both dollar-denominated EM bonds (lower currency risk) and local-currency EM bonds (higher risk, higher potential return) are available through ETFs like the Vanguard Emerging Markets Government Bond ETF (VWOB).

Portfolio Allocation Guidelines

How much to allocate to emerging markets depends on your overall investment approach and risk tolerance:

• Global market weight (~12%) — A market-cap weighted global portfolio puts roughly 12% in EM. This is a reasonable default for investors who want broad global exposure.
• GDP-weighted (~40%) — If you weight by economic output rather than market cap, EM gets a much larger allocation. Most advisors consider this too aggressive.
• Practical range (5-15%) — Most financial planners recommend 5-15% of total portfolio in EM. Aggressive investors with long time horizons might go to 15-20%.

Within a stock allocation, a common breakdown is 60-70% U.S., 15-25% developed international, and 10-20% emerging markets. If you are already underweight international stocks (as many U.S. investors are), adding EM exposure can significantly improve your diversification.

MavenEdge Finance offers international and emerging market asset class buckets that make it easy to see how EM allocation affects your portfolio's overall risk-return profile and how different EM weightings have performed historically.

Common Mistakes in EM Investing

Chasing Last Year's Winners

EM returns vary enormously by country and year. The best-performing EM country in one year is often among the worst performers the next. Broad diversification across countries is far more reliable than trying to pick the next hot market.

Ignoring Currency Impact

U.S. investors sometimes focus only on local market returns and ignore the currency effect. A market that rises 15% in local currency terms but whose currency depreciates 10% against the dollar delivers only about 5% in dollar terms.

Treating EM as Monolithic

China, India, and Brazil have almost nothing in common economically. Treating "emerging markets" as a single bet ignores the vast diversity within the category. Understanding the differences helps set realistic expectations.

Giving Up Too Soon

EM can underperform U.S. stocks for extended periods (as they did from 2011-2020). Investors who abandon EM after years of underperformance often miss the subsequent rebound. Like any asset class, EM has cycles, and long-term investors are typically rewarded for patience.

The Bottom Line

Emerging markets investing offers genuine long-term growth potential and diversification benefits that are difficult to replicate with developed market stocks alone. The risks are real — currency volatility, political instability, and governance concerns — but they are compensated by higher expected returns and lower valuations.

For most investors, a 5-15% allocation to emerging markets through a low-cost, broadly diversified ETF is a sensible addition to a well-constructed portfolio. The key is setting realistic expectations, maintaining a long time horizon, and resisting the urge to abandon the allocation during inevitable periods of underperformance.