How investing in emerging markets is getting more complicated

Like “third world” before it, “emerging markets” no longer makes much sense as an investment category

Shoppers outside a Samsung store

Is South Korea an emerging market? RThe index-makers don’t agree. (Yuan Shuling/ImagineChina/Corbis)

If you’ve ever wondered why most investors treat emerging markets as one monolithic region, look back to 2001. That was the year Jim O’Neill, a Goldman Sachs economist, first spoke about the BRIC countries: Brazil, Russia, India and China, he said, were going to experience a growth explosion, which would result in compounding returns for companies operating there. He was on to something at the time, but the idea that these economies can be lumped together has come and gone. Last October, Goldman Sachs shuttered its once popular BRIC fund after losing 88% of its assets over five years.

When O’Neill coined the BRIC acronym, there were only four emerging markets large enough to warrant investor interest, notes Christine Tan, a portfolio manager with Toronto’s Excel Funds. Now, MSCI’s Emerging Market Index includes stocks from 23 nations. When GDP growth was booming across the developing world, investors could get away with holding a broad index-hugging fund. Today, the differences among these regions have become more pronounced.

For instance, China is becoming less of an export economy and more of a domestic one. Russia, faced with international sanctions and falling oil prices, is a wasteland for many investors. South Korea, included in some emerging funds but not in others, is home to a few of the world’s best-known consumer brands.

Tan says investors should now consider a more bottom-up approach to emerging markets investing. As these markets have matured, they’ve given rise to multinationals that can survive regardless of whether the home country is growing its GDP. In fact, Tan pays less attention to GDP growth emerging markets than she ever has. “The macro is slowing, but I’m still invested,” she says. “Today, countries are more differentiated, and that presents more opportunities.”

It’s the same approach Jon Palfrey takes. “It’s about buying attractive companies and not targeting countries,” says the senior portfolio manager at Vancouver’s Leith Wheeler Investment Counsel.

Still, people shouldn’t forget about the political, corporate governance and transparency issues many nations are currently dealing with. Palfrey won’t invest in Russia, not because there aren’t good companies—stocks are dirt cheap there right now—but political risks outweigh the potential rewards. However, he is invested in Brazil, Korea, China and other regions that have fewer political liabilities.

The problem with owning a broad index fund is that you end up invested in many different countries that do not act like one another. Tan recommends opting for an active fund manager who can adjust the allocation to more attractive markets. You could also buy country-specific exchange-traded funds, or you may instead consider an ETF that invests in a trend.

And these thematic opportunities abound, says Tan. Many emerging markets have growing health-care needs; consumers are getting wealthier and buying higher-quality food and discretionary items; and the travel sector is also attractive, she says.

Whatever you do, don’t forget that these are now more mature economies with unique strengths and weaknesses. “BRIC was always an elegant way to think about emerging markets,” says Tan. “Now these countries drive their economies in different ways.”