Written by Martin Small

Emerging markets (EM) have grown substantially, both as an economic force and an asset class, since 1988 when the MSCI Emerging Markets Index was launched. EM’s transformation in both shape and size has been building for decades, and has been driven by the convergence of several key trends, with long-lasting impacts,[and]...has opened potential investment opportunities that simply didn’t exist three decades ago. [Both issues are addressed in this article].

...Back in 1988 the EM index represented just 10 countries and less than 1% of world market capitalization [but now]...has grown to 23 countries representing 11% of world market cap. Take a look at the chart below. China (added to the index in 1996), once a mere 0.5% sliver, now consumes more than a quarter of the index.

(Click on image to enlarge)

...[Below are the key trends that have impacted the transformation of EMs:]

1. Dedicated investor base

More and more institutional investors have made broad EM a strategic portfolio allocation, rather than a discretionary, risk on-risk off trade. These longer-term commitments have attracted “stickier” money to the asset class.

2. Divergence among economies

Developing countries have seen across-the-board economic growth, but they have done so at vastly different rates. Where burgeoning prosperity once lifted the entire asset class, wealth is now more dispersed, as some economies mature earlier than others. Think of India, with its large services sector, versus oil-driven Qatar.

3. Rise of the local investor

Stock and bond markets in places like Mexico, emerging Asia and Eastern Europe have benefited from the emergence of local pension plans and insurance companies, which need to invest to keep pace with their liabilities, as well as the growing number of individual investors.

4. Development of bond markets

The improvements in local fixed income markets have not only helped stabilize interest rates, but also provided an additional entry point for investors.

5. Easier access through ETFs

Finally, the creation of investment vehicles such as exchange traded funds (ETFs) has provided liquidity and accessibility to markets that are often difficult for foreigners to access.

The evolution of emerging markets has opened potential investment opportunities that simply didn’t exist three decades ago.

• For one, the category should no longer be viewed solely as a monolithic asset class. The MSCI EM Index, for example, contains both the world’s second-largest economy, in China, and comparatively tiny Chile, with an index weighting of 1.1%.
• The index represents 23 distinct currencies, business cycles and geopolitics, among other factors—each with unique impacts on market performance.

As a result, many investors now choose to express a view on smaller or specific markets, particularly as economic divergence becomes more pronounced. The ability to “de-cluster” emerging markets, and access them with single-country ETFs, can help investors to pinpoint and potentially capitalize on these differences. This is not to suggest that broad EM investing is dead [because] funds such as iShares Core MSCI Emerging Markets ETF (IEMG) and iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV) can play an important role in a core portfolio, providing long-term growth potential and diversification.

Single-country ETFs, [however,] can serve as precision instruments alongside the core of a portfolio, providing another simple and cost-effective tool to tap potential opportunities in the world’s fastest growing economies. Investors interested may want to consider iShares MSCI India ETF (INDA), iShares MSCI Indonesia ETF (EIDO) and iShares MSCI China ETF (MCHI).