Let’s start reviewing the characteristics and differences between an investment in an emerging market and one in a developed market.
Today, we will look at this topic in terms of risk of losses.
This is an easy win for the developed markets clearly. There is in fact no doubt that investing in a developed market like the US one involved less risks than investing in an emerging or frontier market. There are a multitude of reasons that can explain this but let's focus on the two main ones here: volatility and different legal systems.
The first reason is volatility.
Volatility can be defined as a measure of standard deviation for asset price moves.
Volatility tends to be much higher in emerging markets than in developed ones. Why? Because the economic systems tend to be less stable in these countries. Economic growth can fluctuate immensely from one year to the other. But also because emerging or frontier markets tend be less liquid than more developed markets.
Another reason lies in the different legal systems. Governments tend to do their best to reassure investors and especially foreign investors. This is something that the most developed countries do better obviously than less advanced countries. In the United Kingdom for instance, all current or savings accounts and cash ISAs in banks, building societies and credit unions are covered by the Financial Services Compensation Scheme (FSCS). So in the UK, if your bank fails, you would get back up to £85,000 per person, per financial institution. Emerging countries are putting in place the same kind of system but of course it will take time for these markets to reassure risk adverse investors.