Global investors are always wary of emerging markets (EMs). They see them as a source of volatility. It is an asset class that can deliver big returns but is also a big source of risk in their global portfolios. It is common to see FIIs flee emerging markets at the first sign of trouble. This 'trouble' can take the form of currency depreciation, political instability, market fluctuations, a black swan event or any other factor.
Why are FIIs willing to bear this risk? The one word answer is growth. EMs or developing economies, are striving to make rapid economic progress. Foreign institutional investors (FIIs) are attracted to the high growth prospects of these economies as the same is harder to find in their respective home countries. But what happens when the risks become so great that they overshadow the appeal of high growth?
According to CNBC, global investors are beginning to worry that EMs may be heading the same way as the European Union (EU). While this might sound absurd at first, on closer examination of emerging markets, the concerns seem to be valid. After the global financial crisis, EMs were expected to lead the world out of the economic slump. While it's true that the growth in these countries was higher than in the developed world; investors have now realized that EMs will be a cause of major occasional worries. Emerging markets seems to resemble the economic mess in Europe, from an investor's point of view.
While EMs may not drag the world into the next crisis, investors are now positioning their portfolios for additional volatility which could arise from these economies. While there are huge differences between the two, the risk from EMs are extremely similar to the risk posed by Europe in one aspect: contagion. This means that in an interconnected globalised world, any negative economic event in the emerging world could potentially, affect the markets in the developed world. This is becoming increasingly apparent as the US fed continues to wind down its QE program. This would mean that investors will have to brace themselves for a potentially volatile year in 2014.