Should you invest into Emerging Markets?
As globalisation continues to connect and fuel growth in economies around the world, one market that has caught the eye of many investors would be the emerging markets. Emerging markets refer to the marketplace that trade financial securities from companies in the countries that are slowly developing and increasing their GDP.
Many companies in emerging markets have the potential of being a good company to invest in in the long run. However, how do these companies fair as investments in the current Covid-19 situation and what affects them outside the context of this pandemic?
Developed countries vs emerging countries during the Covid-19 Period
To decide if certain companies in emerging countries are suitable to invest in, we must look at the macroeconomic factors that affect it.
Developed countries like the US, can print an unlimited amount of money while ensuring that its currency remains well supported. Emerging countries on the other hand do not have this ability. In fact, they are more likely to owe debt to other countries in foreign currencies like the US dollar[1].
Many countries like India and Indonesia must borrow from other countries to fuel their own growth. However, if they were to print their own currency, their currency will depreciate[2] and their debt would not get any lesser because they owe other countries the same amount in US dollars. Hence, the country will still suffer from a high level of debt and a depreciated currency even if it prints money.
As such, the countries that are the most dangerous to invest in will be those with high amounts of foreign debt, as they are unable to print money like the US. Hence, in this Covid-19 pandemic, we must be very careful about the sovereign solvency issue[3] which will in turn affect the company’s solvency[4].
Investing in emerging countries outside the context of Covid-19
Emerging countries tend to grow faster than developed countries. They normally have a younger population and start from a lower standard of living and income. As their economy grows and their purchasing power increases, their consumption will grow rapidly. This is a good reason to invest into emerging countries.
However, before jumping into the emerging markets, you must understand what to look out for.
Looking out for corporate governance when investing
An important factor to keep in mind would be corporate governance. Taking note of corporate governance means that we must look at how the company is run. This means that we look at the management and board of directors for a better understanding of the company processes, structure, and relations before investing into it. Furthermore, this allows us to better comprehend how the numbers on their financial statements relate to the company’s practices.
By looking at corporate governance, we also have a better view of their treatment of minority shareholders[5] who are retail investors like us. Companies without an honest management could easily cheat minority shareholders by issuing shares at a preferential price to their friends and themselves. This means that by looking into corporate governance, we can avoid being short-changed by the companies we invest into.
How to pick your investments in emerging markets
The first way would be to invest into a company whereby the majority shareholders[6] are known to have integrity. For example, the majority shareholder could be a long-standing European company that has influence over the structure and management of the company from the emerging country. This should give you some assurance as an investor that the corporate governance of the company is well taken care of and is trustworthy.
The second way would be to avoid companies that are new and have no track record. This is because these companies have a higher probability of risk when compared to companies with good track records. Hence, even though their returns might seem good, I would advise that you give more priority to the risk that could be involved when investing into the company. Thus, even though you might not make good returns, this character of risk aversion will ensure that you do not lose money because of poor corporate governance.
I hope that you have learnt how to select a company to invest into via both the country’s governance and the corporate’s governance. Indeed, we should learn to look beyond the financials of the company[7] to have a better inkling of whether the company will be one you would want to invest into.
If you have any questions about your personal investment portfolio or want to learn how to better reap the opportunity you are now having, feel free to reach me via heb@thegreyrhino.sg or 8221 1200.
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[1] To find out why the US dollar is used so widely, you should read this article: How the U.S. Dollar Became the World’s Reserve Currency by Investopedia
[2] Currency depreciation: As countries print more of their own money, the supply of their currency will increase while the demand remains stagnant. This means that there will be a surplus and the value of the currency will reach a new equilibrium by dropping or depreciating.
[3] Sovereign solvency issue: The country’s ability to pay their debt owed to other countries.
[4] Company’s solvency: The company’s ability to pay their debt and other financial obligations.
[5] Minority shareholders: They control less than 50% of the shares and have no voting rights in the running of the company.
[6] Majority shareholders: It could be a person or entity that control more than 50% of the company’s shares and has voting rights in the management and direction of the company.
[7] If you want to read more about the different factors to consider when you select companies to invest into, you can read my previous article: All you need to know about Stock Valuation