What Are Emerging Markets and Should UK Investors Own Them?

What Are Emerging Markets?

Emerging markets refer to countries whose economies are growing rapidly but have not yet reached the full development level of wealthy nations like the UK, US, Germany, or Japan. The term encompasses a broad spectrum: large economies like China, India, Brazil, South Korea, and Taiwan, and smaller, faster-growing nations like Vietnam, Indonesia, Mexico, and South Africa. The index provider MSCI maintains the most widely used classification, dividing countries into developed markets, emerging markets, and frontier markets based on their economic development, market accessibility, and trading infrastructure.

Why Consider Emerging Markets?

The case for including emerging market equities in a globally diversified portfolio rests on several arguments. First, demographic advantage: many emerging economies have large, young populations driving rapid economic growth and consumer spending growth. Second, growth premium: historically, emerging market economies have grown faster than developed economies, and this growth has at times translated into stock market outperformance. Third, diversification: emerging markets do not always move in lockstep with developed markets, providing some diversification benefit. Fourth, underrepresentation: emerging markets account for approximately 40 per cent of global GDP but only about 10 to 12 per cent of global market capitalisation — suggesting potential long-term realignment.

The Risks of Emerging Market Investing

Higher potential returns come with meaningfully higher risks. Political risk is significant — governments in emerging markets sometimes expropriate assets, change regulations dramatically, or experience political instability that devastates markets. Currency risk is higher as emerging market currencies are often more volatile than sterling, the dollar, or the euro. Governance risk is real — corporate governance standards are generally lower, with more state-owned enterprises, less transparency, and weaker minority shareholder protections. Liquidity risk means some emerging markets have less liquid stocks that can be harder to sell in a crisis.

China: A Special Case

China is by far the largest component of most emerging market indices, typically representing 25 to 30 per cent of the MSCI Emerging Markets Index. Investing in China through an ETF means accepting significant exposure to the geopolitical tensions between China and Western economies, the regulatory uncertainty of the Chinese government's interventions in its own stock market, and the specific risks of Chinese company structure — particularly the VIE structure used by many Chinese technology companies listed overseas, which does not confer direct ownership of Chinese operating entities.

How to Invest in Emerging Markets

The simplest approach for UK investors is an emerging market ETF. The iShares MSCI Emerging Markets ETF (EMIM) provides broad exposure with an OCF of 0.18 per cent. The Vanguard FTSE Emerging Markets ETF offers similar coverage. Both are available on major UK platforms within ISAs. Alternatively, the Vanguard FTSE All-World ETF already includes approximately 10 to 12 per cent in emerging market stocks as part of a single global fund — an effortless way to get some emerging market exposure without a separate allocation.

How Much Should You Allocate?

For most UK retail investors, a modest allocation to emerging markets — 5 to 15 per cent of your equity allocation — captures much of the diversification benefit while limiting exposure to the specific risks described above. Investors who already hold a global all-world fund like VWRL already have emerging market exposure built in and may not need a separate allocation. Those who hold a developed-world-only fund like MSCI World might consider adding a small emerging markets allocation to complete their global coverage.