They may have set up the first fund 10 years ago, but there is still no consensus even today in defining an emerging market. The IFC has its own definition as does the World Bank. And if you were to ask the Templeton fund manager Mark Mobius, it would be different again.
The IFC categorises emerging markets as those with low or middle income economies and where a process of change has commenced. The markets in such a case have begun the process of growth and are becoming rationalised. On the other hand the World Bank defines a developing economy as one in which the per capita income in 1992 was less than $8356 in 1992.
From this definition there are 170 emerging markets in the world, of which roughly 34 are located in East Asia, the Pacific and South Asia. Mark Mobius, emerging markets fund manager at Templeton, thinks that three criteria need to be examined when identifying an emerging market. Countries are emerging markets when they have low or middle capita incomes and undeveloped capital markets, or are not industrialised.
These differences in definitions can lead at times to confusion. Can one say that Hong Kong or Singapore is an emerging market ? According to Mobius' definition they would not. Yet in practice they are considered as emerging markets by many. Also, of the emerging markets that have been identified it is possible to invest in only a handful.
However, emerging markets tend to show certain characteristics by which they may be identified. These include, a rapidly industrialising economy, with the earlier contribution of agriculture to GDP coming down.
In some cases a movement away from the socialist kind of state run enterprises to privatisation. Emphasis on new technology, development of capital markets, change in laws, easier access of foreign capital, and reforms in the banking sector are also some other characteristics.
For what they are worth, techniques in studying risk versus returns in emerging market investments are far more refined. One popular ratio has been devised by WF Sharpe. It measures risk versus returns by calculating the mean monthly return from a stock market over a period of time and dividing this figure by the standard deviation over that period.
What you get is the Sharpe ratio, or the risk to return trade-off. In layman's terms this ratio is simply the average or mean return from an investment, divided by the 'average' possibility of deviation from the return. The higher the ratio the lower the risk as compared to the return and vice versa.
Based on a study from data taken from 1990 to 1994, the IFC Emerging Markets Database has listed the Sharpe ratio of 19 emerging markets and 18 developed markets. The results are surprising; 12 emerging markets have a better risk return ratio than all the developed markets except one, Honk Kong.
While it is expected that the returns in emerging markets should be higher, so should the risk. But it seems that emerging markets make for better investments anyway. Of course the latter should be taken with a pinch of salt; other factors such as inflation and currency exchange rates have not been considered. Within emerging markets the Mexico had the highest Sharpe ratio, while Portugal has the lowest. India ranks 11th. Some other interesting trends in emerging market are based on long term movements. It has been seen that emerging markets tend to move less due to industrial reasons, than market reasons. That makes investment decisions more difficult.
For developed markets its is the other way round. Lastly, individual stocks in emerging markets tend to move with the markets more systematically than in developing countries.
