Since the Great Recession of 2007-09, US stocks have significantly outperformed those of developed international markets as well as those of emerging markets.

Looking back on a decade of under-performance, some investors may be questioning why they should invest in higher risk emerging markets stocks.

It has been over 30 years since emerging markets investing entered the mainstream. It has changed from an exotic bet to a key component of any properly-diversified portfolio. By the late 1980s, emerging markets became a financial industry label for what many had previously referred to as the “third world”.

In 1987, two landmark events occurred, which changed the led investors to view emerging markets as developing countries with growing investment opportunities. First, MSCI published its first emerging markets stock index, and second, the Templeton Emerging Markets mutual fund was launched. The fund invested in five economies with a combined market capitalization of below $100 billion that year – Hong Kong, the Philippines, Thailand, Malaysia and Singapore. Today, the market capitalization of those five economies exceeds $2.5 trillion.

During the 1990s, the stocks tracked by the MSCI Emerging Markets Index sometimes out-performed or under-performed the developed markets index by forty or fifty percentage points in a year. When one country encountered financial difficulties – such as when Russia defaulted on its bonds, or Mexico experienced a currency crisis – investors tended to abandon all emerging market stocks.

Today, many emerging market economies are larger and more robust than they were decades ago. Emerging markets stocks still tend to experience greater volatility than their developed market peers, but the differences have become smaller over time.

Two key members of most emerging markets indices – Taiwan and South Korea – have performed so well that they are now at least as wealthy as developed markets like Italy and Portugal (as measured by “purchasing power parity”).

Countries in the MSCI Emerging Markets Index include Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. Companies included in the index include household names like Alibaba Group, Samsung, LG and Hyundai, to name just a few.

So, why do we invest in emerging markets stocks?

To capture where the growth is today, and for the foreseeable future. Emerging economies are expected to grow two to three times faster than developed nations like the US, according to International Monetary Fund estimates.

According to Oppenheimer Securities, between 2018 and 2050, the working age population in emerging market countries is expected to increase by 135%, even as the working age population in the developed world is expected to decline by 7%. Population growth, along with productivity improvements, should lead to far better growth in emerging markets over the next thirty years relative to the US and other developed market countries.

Also, while the volatility of many emerging markets stocks seems to have decreased, investors can still capture the benefits of diversification by including them in their portfolios, because the performance of these markets is not perfectly correlated with that of developed markets. The table below shows just how dramatically asset class returns can vary from year to year.

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