What makes a market "emerging"?

Emerging markets have their origins in the 1980s. Today, a professional investor probably thinks they have some idea what an emerging market is. On the other hand, an inquisitive lay person with a few pointed questions quickly unravels the lariat: why is Korea an emerging market? Why is Nigeria not?

Most emerging market investors would struggle to call to mind the conditions of their creation; even fewer would seem to have a vision of what they should be in 10 or 20 years’ time (arguably that should matter to long-term investors). In the current situation, we have a triumph of commercial interest over the common sense, and the situation is like the movement of mantle underneath the Californian coastline.

Defining features of an emerging market

I put forward this point more than a year ago, but it is worth making a more pointed statement now about what it really means to be investing in emerging markets. Historically, the emerging markets were the “Third World” countries: emergent or unaligned to Capitalist or Communist imperialist spheres of influence.

In the 1980s, with the gradual disintegration of Soviet Communism and post-Bretton Woods, these markets emerged from their Third World or Communist status. Open capital markets and corporate governance standards were prerequisites for their emergence, while dramatic increases in GDP and GDP per capita were symptoms of this change driven by inflows of capital and integration into capitalist systems. None of the former were a strictly definitive criteria in a benchmark sense.

Taking the current grouping of markets considered to be “emerging”, we find that very few of them are actually emerging in any historically consistent or practical sense. The exception to this might include China over the last decade. The most consistent defining feature of emerging markets in a post-communist, post-modern era is that they are non-dominant, subordinated but integrated capital and currency blocks. I am tempted to suggest they are “immanent” markets. This is the reason it is consistent for me to see countries like Korea and Hong Kong as “emerging”, whatever the definition proffered by the benchmark establishment. Hong Kong, for instance, is a capital market pegged to the U.S. dollar and at risk of being subsumed into the Chinese capital and political system. South Korea, meanwhile, is subordinate to U.S. military OPCON, and its currency is dependent on U.S. Federal Reserve support in times of crisis.

Investing in emerging markets

What this means for managing an “emerging market” portfolio, particularly one with aspirations to provide returns long into the future, is that not every stock that is bought for the portfolio can possibly be strictly defined as “emerging markets” by narrow benchmark criteria.

These criteria are themselves not practical or consistent (we have already made this point with the inclusion of stocks like HSBC or National Bank of Abu Dhabi). Rather, the aim is to have a basket of stocks that is “emerging market” in nature through general exposure to what we consider to be emerging market dynamics – subordinate capital blocks.

Part of the reason for dwelling on this point this month is a lengthy internal debate we have had over the eligibility of Transocean Ltd. for the portfolio. The company is not an emerging market stock by any strict criteria, but (arguably) fits well into and is complementary to the aims of an “emerging market” portfolio. To hinge the debate on whether this stock could be “officially” classified as emerging market was not the right approach. The company has 48% of its oil rig assets in emerging markets (which is also where the growth is likely to be), and has plenty of “emerging” characteristics. In addition, we see clear evidence of the market for oil rig services and maintenance having bottomed, which is why the stock now finds its way into the portfolio.


In February, global markets suffered a correction, but I remain confident of the relative performance and of the trend for emerging markets. I would reiterate a few points I have made previously:

  • We have not yet reached the 2007 high watermark for the MSCI Emerging Markets Index (and I think it is inconceivable that we don’t);
  • To the extent that this recovery in emerging markets will be driven by further recovery in trade and capital flows, the rally is likely to be broader in nature than it has been hitherto; and finally
  • Corrections are opportunities as much as they are risks.


 – Edward Lam, Lead Manager



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