EMs vs DMs: Millennial economist Piya Sachdeva explains Emerging vs Developed Markets
What does it take to “slide into a DM”? No, we’re not talking about flirting with someone on Instagram.
In the investment world, “DM” stands for developed market… as opposed to an emerging market, or “EM”.
Why should millennials care about the difference between EMs and DMs?
Firstly, nearly nine in every 10 millennials live in emerging economies. In fact, according to the FT’s “Millennial moment” series, Chinese millennials alone outnumber the entire population of the US. Mind-blowing, right?
When thinking about investing, emerging markets generally have a long-term growth story, but the prices of their assets can be volatile (in other words, move up and down sharply). Even if emerging markets are undergoing rapid growth on their way to becoming developed markets, they are still vulnerable to global economic shocks – usually even more so than developed economies. So what might perform well in the long-term could be a minefield in the short-term.
From this perspective, emerging markets may be attractive to younger investors, who do not mind more volatility. Having said that everyone’s investment objectives are different, and as with any investment, there is of course risk involved there is no guarantee you will get back your original investment. Ultimately, EM is seen as a higher risk, but on the flip side is seen to offer higher returns.
What is the point in grouping markets?
The US or UK is quite different to Turkey or Mexico. When thinking about where to invest, we can identify characteristics across different economies or markets and split them into broad categories to make it easier to navigate. This way we can think about investment themes.
How do you define emerging or developed markets?
As we dig a bit deeper into the groupings, where you draw the line is quite tricky and does differ depending on where you look. As you might expect, the stage of economic development is important, but a range of other factors are also taken into account.
The International Monetary Fund (IMF), an organisation of 189 countries working to foster financial stability, looks at:
1) Per capita (head) income level
2) The diversity of a country’s exports
3) How much a country is integrated into the global financial system
MSCI, the provider of stock market indices, uses a different definition of EM when building its Emerging Markets Index. It combines all the EM equity country indices into one broad index. MSCI takes into account things like the size of the market, ease of trading and adequate regulation.
Which countries are the EMs and which are the DMs?
The obvious example of developed markets are the US, UK, Canada, Japan and Germany. Emerging markets include the famous BRIC economies: Brazil, Russia, India and China.
According to MSCI, EM also includes Chile, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Turkey and United Arab Emirates.
If you have ever been to Korea, it probably won’t surprise you that it is borderline as the IMF does not classify it as emerging.
What to consider before investing in emerging markets
EMs tend to have idiosyncratic stories but there are some factors that tend to drive EM as a whole. As emerging markets are more risky, the broader risk environment is something to take into account. So, for example, if the global economy is going into recession, it is not a good idea to buy EM – even more so if you’re focused on short-term performance.
The US dollar is also important. Lots of emerging market economies sit on debt in dollars rather than the country’s own currency. As the dollar strengthens, it takes more of the emerging market’s own currency to pay the same amount of US dollar debt. For similar reasons, US interest rates are key as higher interest rates also makes the debt harder to pay back (similar to what would happen to our student loan debt if interest rates started going up!).
In terms of recent market performance, in a backdrop of US interest rates rising and a strengthening dollar, emerging markets have struggled. In particular some of the more vulnerable economies, such as Argentina and Turkey, have experienced major “sell-offs” (the rapid selling of equities such as stocks).