Emerging Markets in an Upside Down World: Challenging Perceptions in Asset Allocation and Investment

Chapter 2

Defining Emerging Markets

What is an emerging market? There are a number of definitions, but prejudice plays a strong part in determining the universe, and with it, history. All countries are risky. My preferred definition is thus as follows: The emerging market countries are those where this risk is widely perceived and priced in (albeit not always correctly). This is in contrast to a developed country, which is one where a substantial portion of the investor base does not perceive the sovereign risk. To move from an emerging to developed country status is thus not a process, per se, of improved credit-worthiness. If it were, many emerging market countries would be considered developed and some developed ones emerging. Rather, joining the club of developed countries, as with those in Eastern Europe who have joined the EU, is a process whereby the government and the bond market reach a consensus that the country can be trusted – its government bonds are even (by some at least) denoted ‘risk-free’ as default risk is fully discounted.¹ Risk and changes in risk stop being priced. Volatility falls, which is also by some taken to mean that risk has reduced (though the opposite may be true). Hence the anomaly is not in the emerging markets, but in our misperception of risk in the developed world. It is that which divides the two types of country. Prejudice is a topic we shall return to.

There are alternative definitions, typically a list of countries – maybe 150 of them. Some ...