The term emerging markets (EM) is relatively modern. It was coined in the early 1980s by Antoine van Agtmael, a former economist at the International Finance Corporation (IFC), partly driven by the desire to make investment in developing countries more attractive to global investors at the time.
Today, as geopolitical concerns remain front and centre, understanding how emerging markets behave — and how they are defined — has become an increasingly important part of investor due diligence.
What are emerging markets?
An emerging market refers to the economy of a developing country that is in the process of integrating into the global economy. According to Investopedia, these economies are marked by rapid growth in GDP and trade, along with increasing foreign direct investment.
What qualifies as an “emerging market” depends on the framework being used. The International Monetary Fund (IMF) divides the global economy into Advanced Economies and Emerging Market and Developing Economies. Any country not classified as advanced falls into the EMDE category. This creates a broad grouping that includes large economies such as China, India, Brazil, Mexico, Saudi Arabia and South Africa as advanced economies, alongside smaller and lower-income countries including Vietnam, Kenya, Ghana, Bolivia and Cambodia as EMDEs.
Index providers such as MSCI and FTSE Russell take a narrower, market-based approach to classifying markets. Their classifications focus on capital market accessibility, liquidity, and investability, rather than overall economic development. These definitions are particularly relevant for investors, as they determine which countries are included in some exchange traded funds (ETFs) and index-tracking funds.
Why Investors May Allocate to Emerging Markets
Some self-directed investors may choose to allocate a portion of their portfolio to EM for a few reasons.
Growth Potential with Volatility
Emerging economies often have more room to grow than mature markets like the United States or Western Europe. According to the World Economic Forum, industrialization, rising incomes, and expanding middle classes are the primary catalysts for sustained corporate earnings growth. That said, growth in emerging markets is rarely linear. Economic cycles can be uneven, and periods of strong expansion are often followed by sharper slowdowns than investors are used to in developed markets. But, over long periods, investment in these markets still has the potential to translate into faster earnings expansion and higher potential returns.
Diversification Across Economic Drivers
Emerging markets don’t always move in sync with developed markets. Their economies are influenced by different factors such as local demographics, infrastructure investment, domestic consumption, and commodity demand. While including EM assets in a globally diversified portfolio can help reduce over-reliance on North American or European equities, correlations between emerging market equities and developed-market equities (particularly North American and European markets) can rise during periods of global stress, meaning diversification benefits may weaken when they are needed most. Ultimately, these assets can help spread risk across more regions.
Currency Dynamics
Currency movements can meaningfully impact returns. A stable or weakening U.S. dollar has historically supported EM assets by improving local earnings conditions and boosting the value of foreign investments when converted back to dollars. For Canadian investors, however, currency works both ways. A strengthening loonie or a weakening local emerging-market currency can reduce returns — even when the underlying investment performs well in local terms. This effect is particularly relevant in sectors where revenues and costs are largely generated in local currency and offer limited natural hedging. As a result, Canadian investors may experience muted or negative returns despite solid local-market performance, underscoring the importance of currency exposure when allocating to emerging markets.
Why This Matters Now
One of the biggest issues for investors today is how concentrated portfolios have become, especially in U.S. equities. A large share of market returns has been driven by a small number of mega-cap companies and a narrow set of sectors including large technology and communication services. This matters because periods of narrow market leadership can increase portfolio risk if those dominant stocks underperform, and may lead to different risk/return outcomes than more evenly distributed market gains.
In a world where geopolitical shocks can quickly impact specific regions or industries, spreading exposure matters more than ever. Emerging markets can offer exposure to different growth drivers such as domestic consumption, infrastructure build-out, financial inclusion, and manufacturing expansion.
Geopolitics Are Re-shaping Global Supply Chains
Geopolitical tensions have pushed companies and governments to rethink where goods are made and how supply chains are structured. This has benefited several emerging economies through nearshoring and friend-shoring, increased investment in manufacturing and infrastructure, and greater demand for local labor and resources. Countries positioned as alternatives to traditional manufacturing hubs may see long-term economic tailwinds that aren’t fully tied to U.S. or European growth cycles.
Valuations and Expectations Are Often Lower
Emerging markets are frequently priced with more pessimism baked in. Political risk, currency concerns, and past volatility tend to keep valuations lower than in developed markets.
For investors, this has the potential for upside if conditions stabilize, with returns that are less dependent on perfect economic or political outcomes. This is especially relevant when developed-market valuations already assume strong growth and relative stability.
Commodity and Resource Exposure
Many emerging markets are key suppliers of commodities? — energy, metals, agricultural products, and materials critical to the energy transition. In periods of geopolitical tension, supply disruptions, or increased defense and infrastructure spending, these economies may benefit in ways that aren’t always captured by developed market indices.
Optionality in a Fragmenting World
The global economy is becoming less unified and more fragmented. Trade blocs, regional alliances, and political considerations seem to be playing a larger role in capital flows and investment decisions. Emerging markets can offer investors optionality — exposure to regions that may gain strategic importance as global economic relationships shift. At the same time, differences in corporate governance and transparency standards vary by country, increasing the importance of due diligence for investors.
How Canadian Investors Access Emerging Markets
Canadian investors typically access emerging markets through several channels:
- Exchange-Traded Funds (ETFs)
- Mutual Funds
- U.S.-Listed ETFs
- Direct Securities and Depositary Instruments.
- Fixed-Income Funds
Balancing Growth With Prudence
Emerging markets are not one-size-fits-all. Performance can vary widely from one country or sector to another, and volatility is part of the deal since EM assets can experience sharper price swings than those in developed markets.
Some analysts suggest keeping emerging markets as a portion of your overall equity allocation, aligned with your risk tolerance and financial goals, with a goal of mitigating short-term drawdowns without derailing your broader investment plan.
Investors looking to build emerging market exposure can do so through Qtrade, which offers access to TSX-listed ETFs, mutual funds, and U.S.-listed ETFs, along with tools and research to help compare options, monitor risk, and maintain diversification.
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