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Emerging markets are making waves — here's what they are

If you’ve been watching the market, you’ve probably been hearing a lot about emerging markets. 

There are a lot of competing viewpoints. “Emerging markets are rising. Now’s the time to buy emerging markets!” “Emerging markets are crashing. Now’s the time to sell emerging markets!”

But if my personal experience is any guide, a lot of you don’t know what emerging markets are.

As you see in the video above, there are many, many countries that are technically emerging markets. They’re countries that aren’t as developed as other countries, such as the United States, Japan or Germany, so they’re classified as emerging. Some of these less-developed emerging markets aren’t technically emerging markets – they’re known as frontier markets. And some, like South Korea, are so developed that experts argue they should be reclassified, but that’s a conversation for another time.

Index makers like MSCI decide how to classify these countries based on a number of criteria, such as gross domestic product per person, ease of doing business and depth of capital markets, which can be subjective.

What are emerging markets?

To put it simply, emerging markets are the countries in the world that many people probably know as third-world countries. The term emerging market is credited to Antoine van Agtmael, an official working for the World Bank, who realized that these countries needed investors to put money in their stock markets and buy their bonds, and that no one wanted to buy or even sell securities from third-world countries. Yuck.

So he decided to call them “Emerging Markets.”

For example, if you want to buy stock in Chinese tech giant Tencent or Korean conglomerate Samsung or Brazilian airline Azul, you would be investing in emerging markets. You can also buy a specific country’s bonds or its companies’ bonds. Or you could invest in currencies like the Colombian peso or South African rand or Indian rupee if you expect that the value of those currencies will increase versus the value of the dollar. There are also tons of emerging market index funds and ETFs you can invest in. The most popular one is called EEM.

A woman walks past a bank electronic board showing the Hong Kong share index outside a Hong Kong local bank Monday, Aug. 13, 2018. (AP Photo/Vincent Yu)

Buyer beware.

There are a lot of things to keep in mind here that make EM investing a bit more complicated than buying stock in, say, McDonalds.

First, if a company isn’t listed in the United States – meaning its stock isn’t sold on the New York Stock Exchange, the Nasdaq, or some other U.S.-based exchange – you may not be able to invest in it directly. The same is true for government bonds.

Also, sometimes things happen in emerging markets that you wouldn’t really think to prepare for in developed markets, like new presidents come in and nationalize the oil companies, as happened in Venezuela. Or a government just decides it’s not going to pay back the “vultures” who issued its bonds, as happened in Argentina. Or the president fires the economic and financial ministers from his cabinet and names his son-in-law the new head of both positions and the currency loses more than one-third of its value, as happened this year in Turkey.

You put all of this together and emerging markets investments are big risk, big reward.

And with market watchers expecting U.S. stocks to start bringing in lower and lower returns in the coming years after performing so strongly over the past decade, and the world growing more and more connected, now is probably a good time to get familiar with emerging markets.

For example, look at autos. Some Japanese cars are made with materials from Canada, parts from Mexico and China, assembled in Korea, shipped to Japan and then sold to buyers in the United States. You also have more and more American companies earning big chunks of their revenue in emerging markets like China. In fact, some of the biggest U.S. companies make a majority of their money there.

U.S. securities have been the only game American investors needed to know for a long time. That’s quickly changing. So don’t miss the boat because you don’t know what’s happening.

Dion Rabouin is a global markets reporter for Yahoo Finance. Follow him on Twitter: @DionRabouin.

See also:

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