Considerations when choosing to invest in developing countries
Introduction
What exactly are Developing Nations?
Similar to how there is no universally accepted definition of what constitutes a developed country, developing countries often share a number of characteristics that make them distinct from their developed counterparts. These countries are further divided into frontier and emerging markets. Even if the lines between these markets are blurry, it is crucial to remember that while some developing markets are frontier markets, not all of them are.
In comparison to developed countries, emerging markets generally show significantly faster economic growth and greater birth rates. These trends are frequently being driven by a younger workforce and population. Despite the quicker rates of economic growth, infrastructure and household income still lag behind developed nations. The capital markets in these nations are also less developed and have not yet been fully incorporated into the global economy. Commonly seen as emerging markets are the BRICs (Brazil, Russia, India, China) and the GIPSI (Greece, Ireland, Portugal, Spain, Italy).
Frontier markets are developing nations with considerably lower per capita incomes than the normal developing nation and very little capital market liquidity. They frequently have not seen significant economic development in recent memory and have the potential to either carry on an existing phase of high growth or initiate one in the future. Only investors with extremely high risk tolerance should consider investing in these nations. Many African and Asian nations as well as the CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa) are regarded as frontier markets.
The Advantages of Investing in Developing Countries
Investors should anticipate better returns from foreign investments in this category compared to investing in developed countries because of the strong economic growth rates seen in developing countries and the higher related risk. However, over the last ten years, investments in established countries have expanded at a rate that is almost twice as fast as those in developing economies. This shows that the increased risk levels of emerging markets have not produced adequate returns recently. Despite this historical conclusion, market conditions at the moment, particularly the fact that equity valuations in the majority of developed economies are substantially higher than average historically, may point to a potential reversal of this pattern in the future
Investment Risks in Developing Countries
As was already established, investing in developing nations typically carries larger risks than in industrialized nations. Economic and political instability is a serious risk. These hazards should not be ignored and are a major issue, particularly in frontier markets. These elements frequently have a strong inverse relationship with political or economic instability. If one of these risks materializes, it could result in large capital losses in the value of investments made in the relevant market.
Another major worry is the risk of currency exchange. Even if investors could receive a considerably higher percentage return in the currency of the developing country, taking into account exchange rates could greatly reduce any investment appreciation. The political and economic stability is also related to this risk.
The potential for currency exchange is a serious concern. Even though investors may have expected a far larger % return in the local currency of the emerging nation, taking exchange rates into account could significantly slow the growth of any investment. This threat also has an impact on political and economic stability.
There is a legitimate concern regarding the accuracy of accounting and financial statements when dealing with investments in developing countries. An investor's belief that a company presented a strong investment opportunity might quickly prove to be inaccurate if the company's financial statements were fabricated.
Prior to making any investments, it is generally a good idea to conduct research and analysis; however, emerging market-specific risks necessitate complete and effective research and analysis on potential investments.
Five investment concepts
1.Risk and return
Risk and return always go hand in hand. The risk increases as the possible reward increases. High-return investments shouldn't ever be sought after mindlessly. Consider your investing objective, time horizon, and risk tolerance. Always pick investments that are right for you.
Risk and return have a positive correlation (a relationship where two variables move in the same direction), but there is a key qualification. There is no assurance that increasing the risk will result in a higher return. Instead, increasing your risk could mean that you lose more money.
The correlation between risk and prospective return is likely to be positive, which would be a more accurate statement. A lower risk investment typically has a lower chance of success. A higher risk investment offers a larger chance of success but also a higher chance of failure.
Investments and Risk
You can think of the risk connected to investments as existing on a spectrum. Short-term government bonds with low yields are on the low-risk end. The middle of the scale could include investments like high-yield debt or rental property. Equity investments, futures, and commodities contracts, including options, fall on the high-risk end of the range.
To maximize returns while reducing the likelihood of volatility and loss, investments with varying levels of risk are frequently combined in a portfolio. Utilizing statistical methods, modern portfolio theory (MPT) identifies an efficient frontier that yields the lowest risk for a specific rate of return. Assets are mixed in a portfolio based on statistical data like standard deviation and correlation using the ideas of this theory.
2.diversification strategy
Every investment carries some risk. You cannot prevent it, but you can manage your exposure to risk with the appropriate plan to lower the likelihood of suffering significant losses. Spreading your risk and diversifying your investments is the easiest and best course of action. Investing in a variety of asset classes, such as equities, bonds, deposits, etc., is an effective strategy.
What is diversification?
When businesses want to expand, they use a diversification approach. In order to boost revenues, it is a practice to add a new product to your supply chain. These goods may represent a new subset of the market that your organization already serves, a strategy known as business-level diversification. Instead, if you enter a new market, corporate-level diversification takes place.
What kinds of diversification strategies are there?
Three main types of diversification tactics are currently employed often. Which are:
Diversification Concentric
Continuity and Diversity
Diversification of Conglomerates
Why do businesses implement a diversification strategy?
For three key reasons, businesses will utilize a diversification strategy. As a result, the businesses that employ diversification strategy are those that:
Must reduce market risk
Need to safeguard their enterprise from rivals
Need to broaden their product selection and revenue
The types of businesses that use diversification strategies are hence frequently under pressure. For instance, you might want to buy the firm that a new rival is taking from you.
The decision to diversify, on the other hand, necessitates extensive research and must often be made under severely pressured circumstances. Let's look at some examples of businesses that use diversification strategies along with their justifications.
Mitigate Risk
When the market is unstable or in a slump, businesses will try to expand their product offering. As a result, their investment is distributed throughout a variety of channels, allowing one product to afford to lose sales while causing less overall harm to the business as a whole.
A general riskiness index can be used to determine how successful the launch of a new product might be. Three key requirements must be met by this:
The attractiveness test by Porter
Entry barriers are lower than expected future earnings.
The better-off test asks whether there is a synergy or competitive edge between these new items.
Unsystematic risk is the reason why businesses diversify to reduce risk.
Competition
Businesses often compare their strategic assets to get a competitive advantage when the competition is fierce. Strategic assets are particular firm resources or competencies that are hard to duplicate or are in short supply.
The kinds of businesses that diversify to shield themselves from rivals may combine with those rivals. In this instance, they eliminate the rivals and start splitting the revenue. Additionally, since there are fewer options for consumers, pricing is less competitive. Businesses may be able to increase their prices thanks to this form of diversity.
Matching or outperforming your competitors with new products is a distinct strategy for diversification for competitive reasons. You may decide to combine diversification with penetration in this situation.
Profits
In order to increase earnings, businesses may decide to diversify. In this situation, concentric diversification is a well-known and effective tactic.
For instance, coffee businesses will expand their menu to include food additions like sandwiches and pastries. This might be sold as an upsell at the register to boost profits. The products are identical to those that have already been demonstrated to sell, thus the risk of diversification remains low.
Similar to this, gyms may decide to expand their facilities by adding a sauna area or physio room. This wouldn't need any extra room, but it might be rented out to bring in another source of money, diversifying the business.
3.Average cost per dollar
This approach is long-term. Regardless of the share price, you consistently (for example, weekly) invest a set sum. This eventually equalizes the cost of purchasing shares and decreases the impact of transient market fluctuations.
Dollar-Cost Averaging (DCA): What Is It?
In order to lessen the impact of volatility on the overall purchase, investors who use the dollar-cost averaging (DCA) investment technique spread out the total amount to be invested among multiple purchases of a target asset. No matter how expensive the asset is, regular purchases are made.
This tactic effectively eliminates a large portion of the intricate work involved in trying to time the market in order to buy stocks at the most advantageous prices. The continuous dollar strategy is yet another name for dollar cost averaging.
Particular Considerations
It's vital to remember that dollar-cost averaging only benefits the investor if the asset increases in value throughout the time frame in question. Over time, dollar-cost averaging does improve an investment's performance, but only if the price of the investment rises. The investor is not protected by the strategy against the danger of falling market prices.
The strategy's underlying premise is that prices will always eventually increase. Without knowing the specifics of the company, employing this method on a single stock could be risky because it might tempt a shareholder to keep buying stock when they ought to be selling instead. The method is significantly less risky on index funds than on individual stocks for less experienced investors.
Typical Dollar-Cost Averaging Example
Joe has a 401(k) plan and works for ABC Corp. Every two weeks, he gets a $1,000 paycheck. Joe chooses to contribute $100, or 10%, of his salary to the employer's plan. He decides to split his allocation 50/50 between an S&P 500 index fund and a large cap mutual fund. No matter the fund's price, Joe can buy $50 worth of each of these two funds every two weeks with 10%, or $100, of his pre-tax income.
The table below details Joe's $100 contributions over ten pay periods to the S&P 500 index fund. Joe invested $500, or $50 weekly, over the course of ten paychecks, but as the cost of the fund rose.
4.Additive Interest
Because interest is earned, your principal (initial investment) grows, increasing your overall return. Compound interest has a snowball effect; the longer you invest, the greater your gains. As a result, it's crucial to start investing and saving early.
5.How does inflation impact financial decisions?
A significant and ongoing increase in the cost of goods and services that people consume on a daily basis is referred to as inflation. As fewer of the same things are now purchased with each paycheck than they formerly were, their effects are frequently seen through the lens of your household budget. However, the regular operation of the economy and investment portfolios can also be impacted by inflation. In light of the current rise, we discuss a few effects of inflation.
We consider five key factors when undertaking investment analysis for our clients
1. Compliance: From the perspective of the investment committee, it may seem obvious that a potential investment is compliant. What is acceptable and compliant can differ from client to client, though. For instance, an investment strategy that may be suitable for a British resident of the Benelux may not be suitable or tax compliant for a US resident of the same location with similar demands. This emphasizes how crucial it is to customize and carefully consider recommendations for each and every client.
There is little point in taking into account the other considerations if a potential investment cannot pass the compliance test.
2. Liquidity: For all international and expatriate clients, we think this is one of the most crucial factors. Life changes, which is something we have often noticed throughout the years of caring for clients. For expats in particular, this is true. Even though individuals tend to stay in one place longer, especially in European nations, there is a potential that you will relocate to another country or return to your own. The timing of this can occasionally surprise you. As a result, we take two actions.
3. Volatility: We operate under the principle of assuming the least amount of market risk or volatility necessary to meet our clients' goals. Volatility and risk, as we have already mentioned, are necessary to produce returns on investment. We make sure the client doesn't take on more than is necessary to reach their objectives. What relationship exists between a specific investment and the individual's own risk profile? How does that investment stack up against its competitors? We take all of these things into account when evaluating investments for each of our clients.
4. Cost & Value – An investment's cost is obviously important, but many costs can be challenging to comprehend. Always search for the OCF or TER (the OCF is the Ongoing Charge Figure which is the replacement term for TER, which meant Total Expense Ratio). This represents an investment's overall cost. We choose investment models that can benefit from wholesale pricing and economical underlying investment models. This may lead to relatively cheaper management costs, which are then passed down to you, the investor. Lower costs result in greater returns and your achievement of your objectives.
5. Return: Performance isn't just about generating a profit on the top line; it's also about how you do it. In the end, what matters is your net return, which is your investment performance returns minus the expenses incurred in generating those returns. Similar to this, it's crucial to analyze returns and how they were produced in relation to risk adoption. In order to rank well in terms of performance and perform well given a certain level of volatility, the possible investment must perform well both in absolute and relative terms. Of course, you must also take into account the constraints, and it might not be worthwhile to make an investment that offers potential for high profits but necessitates keeping money locked away for long periods of time, jeopardizing liquidity.
Conclusion
Dollar-cost averaging is a straightforward strategy that involves making regular, fixed investments over a lengthy period of time in the same stock or fund. You are already employing this tactic if you have a 401(k) retirement plan.
We consider five key factors when undertaking investment analysis for our clients.
These are:
1. Compliance
2. Liquidity
3. Volatility
4. Cost & Value
5. Return
Due to overuse, the word "investment" has become confusing. An investment could be a stock or a bond. Nowadays, people are urged to spend money on things like flat-screen TVs, vehicles, and higher education. All of these items could make good financial sense, but they aren't investments in the traditional sense.
Despite what the advertisements may claim, there are only three fundamental types of investment. They are goods that are bought with the hope that they would bring in money, make a profit, or both.
Really Estate
Investments include buying homes and apartments to rent out or sell later.
Your home may serve a variety of functions. It meets a demand for protection. Depending on the state of the market, it can lose value over time or gain value over time. In essence, your home not only fulfills your basic needs but also has the potential to generate revenue if you decide to sell it for a profit.
Stock
Owning stock entails owning a stake in a business. Even though it's a tiny portion, it's still ownership.
All traded assets, including futures and currency swaps, are ownership interests in a broader sense. Investors buy them in hopes of sharing in the profits, anticipating a growth in value, or a combination of the two.
Business
An investment is made when funds are used to launch and maintain a firm.
Due to the fact that it involves more than just money, entrepreneurship is one of the most difficult investments to make. Entrepreneurs can amass enormous personal fortunes by developing a product or service and selling it to those who are interested in it. One of the richest persons in the world and the founder of Microsoft, Bill Gates, is a good example.