Emerging Markets
August 17, 2010 9:40 AM   Subscribe

How can I passively invest in China, Brazil, and India for the long-term? 10-30 years. Help me understand the risks associated with these emerging markets. Should I simply dump my cash into iShares like EWZ or FXI and let it sit? Should I invest in individual companies? Index funds like the Vanguard Emerging Markets? Any thoughts on these investments for the long term? I am a passive investor that usually dumps money into Vanguard index funds. Isn't investing in China and India over the long term kind of a no-brainer? Help me understand what is involved in emerging markets and how I can get better returns than my Electric Orange account.
posted by jasondigitized to Work & Money (7 answers total) 3 users marked this as a favorite
If that strategy is a no-brainer, it's already been priced into current equity values.

You'd want to invest in country-specific iShares ETFs if you think those markets are still undervalued, but the standard passive investor question to ask is "What do you know that the market doesn't?" Furthermore, even if China, Brazil, and India continue to grow at a rate of 10% a year, that doesn't guarantee that their stock exchanges will do the same.
posted by Lifeson at 10:09 AM on August 17, 2010 [2 favorites]

I am personally heavy on EWZ and a latin american mutual fund with a lot of exposure to Brazil. I also hold Petrobras directly.

On the other hand, I would not touch China with a 10-foot pole. As mentioned, economies could do well, but that doesn't mean the stock markets will reflect that.

But yes, obviously, if you want passive investing, you need to go with an ETF or mutual fund. A full emerging market index fund like the Vanguard one is a good choice, especially if you don't have a strong inclination toward any particular country.

Also keep in mind that if you are bullish on emerging markets, you are almost by extension bullish on energy and materials, and there will be a lot of overlap in the holdings of the two, particularly with regard to Brazil.

As far as what to expect/know about investing in emerging markets, you should be aware that exchange rates will affect returns and therefore add to volatility. Also, many emerging markets are not stable, either socially or politically, despite what we've seen the past decade or so. So take that into account.

All that said, with a 10-30 year time-frame, you absolutely will experience severe ups and downs in your investments, but it will all average out in the end.

I believe that emerging markets will somewhat outperform global large caps, but it's not as if they will do well while the rest of the world tanks. They are called emerging for a reason, and if the global economy suffers, they will likely suffer even worse.
posted by eas98 at 11:15 AM on August 17, 2010

Isn't investing in China and India over the long term kind of a no-brainer?

As Lifeson said, the market prices in expectations. So if everyone expects Google to post a huge profit next quarter and they do, the price won't move much from that, it will only cause a big swing if they under-perform or over-perform based on their overall market expectations. For example, it seemed like a no-brainer to invest in Japan in the 80s, but that was right before the bubble burst and sent the country into a decade-long recession. In fact, that's how most bubbles are created, tons of investors decide that a certain asset is a sure thing (tech stocks, mortgage-backed securities, etc.) and pay way too much for it until eventually the bottom falls out and prices crash.

If everyone thinks China and India are going to outperform other regions in the long term, then the price you'll pay to invest will already reflect that to a large extent. If you think the market is underestimating how well they will do (which you probably don't have enough inside information to really know) then you should invest specifically in those regions using the sorts of ETFs and index funds you mentioned, trying to keep costs at a minimum. If you aren't sure that you know better than the market does, then you should just keep your assets diversified across the world so that you can make money on whatever countries do well on the long term (as long as the overall world economy stays healthy).
posted by burnmp3s at 11:20 AM on August 17, 2010

Isn't investing in China and India over the long term kind of a no-brainer?

Academic studies have shown that there is an inverse relationship between high growth countries and high investment returns. So your intuition is empirically wrong. There are various reasons as others have noted above. Most important is that these stocks tend to be overpriced. There is also political risk, more widespread corruption and higher transaction costs.

This is a very common misunderstanding. High growth does not equal high investment returns.
posted by JackFlash at 1:43 PM on August 17, 2010

Disclaimer: I know nothing about stocks and shares, but...

...couldn't you just buy some currency?

I'm sure it's not that simple, but if you are betting on a country growing, wouldn't the strength of the currency reflect that?
posted by Acey at 2:40 PM on August 17, 2010

Response by poster: So the growth of the U.S. economy since 1910 has not run in parallel to the stock market?
posted by jasondigitized at 3:19 PM on August 17, 2010

So the growth of the U.S. economy since 1910 has not run in parallel to the stock market?

Parallel would not be a good description because the curve for growth of the economy and the curve for investment returns can have different steepness so are not parallel. It is the relative steepness of the curves that is important and it can vary from country to country.

The assumption you are making is that countries whose economies grow faster will have higher investment returns. That turns out not to necessarily be the case.

Think about this crude example. Let's say that China is growing twice as fast as the U.S so you would think that it would be best to invest in China. But what if it turns out that stocks in China cost three times as much as stocks in the U.S. You would be able to buy more shares in the U.S. and it would be a better investment than China. China may be growing faster but its stocks are so expensive that the investment return is lower than a slower growing country.

This is exactly what empirical studies have shown. Investments in slower growing countries produce better investment returns than faster growing countries that are over-priced.
posted by JackFlash at 5:02 PM on August 17, 2010 [1 favorite]

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