Emerging market (EM) investing is a different animal than developed markets (DM) investing.

It is worth learning and understanding the key differences, however, as the “lowest hanging fruits” (most attractive opportunities) often are located in EM. In addition, more and more developed market companies outsource their supply chain/manufacturing responsibilities to companies in EM.

There are four main risks associated with emerging markets:

Price Risk: EM stock and bonds can lose money, depreciate in value, just like their DM counterparts. There is, however, an important difference.

• Banks, manufacturing and commodity companies tend to dominate EM indices, resulting in less sector diversification than you typically get with developed markets.

• In other words, EM and DM markets both have price risk, but the concentration of sector exposures makes (price) risk management different.

Foreign Currency Risk: When you invest in a foreign market, you are simultaneously taking a currency position, whether you want to or not.

• For example, to buy a Chinese stock, you have to first convert U.S. dollars into China’s renminbi/yuan to complete the purchase. When you sell the foreign equity, you will also be selling the foreign currency, to convert your gains/losses back to U.S. cash.

• The total return from your EM portfolio is the sum of the local price return (with dividends) plus the currency return (i.e., the change in the value of the exchange rate during your holding period).

• Two is sometimes better than one, sometimes not. EM investing can be particularly attractive when both the price and currency move in your favor. On the other hand, EM investing can be very costly during periods of dislocation when both risks move against you.

Liquidity Risk: Many emerging markets are not as “deep” or as developed as the U.S. capital markets.

• Lower average EM trading volumes can be particularly important when many foreign investors are all trying to get in or out of their positions at the same time.

• EM liquidity risk can be significant during times of turmoil when all trading volumes are depressed. The concern is magnified since many investors will seek the “safe haven” shelter of developed markets during times of turmoil.

Quality Control Risk: The accounting, legal and regulatory infrastructure, that underlies investing, differs from country to country. Most developed markets use a fairly standardized Western infrastructure; some emerging countries do not.

I have highlighted, what I think are, the four key differences but the list is far from comprehensive. What was the point of discussing the differences? EM presents unique areas of opportunities, as well as obstacles, in the wealth building process.

Bottom Line: I believe EM investing is something all investors should consider. To do this, we have to resist home bias – the bias of investing only in our home country. The world is becoming more and more integrated and are portfolio holdings should reflect this structural shift.

How important is EM? EM tends to make up somewhere between 9-15% of the total global stock market capitalization. That number (9-15%) varies over time, as market prices shift, but has been steadily growing and is expected to continue to grow. The U.S. now accounts for less than 50% of the global market cap. In other words, investing only in U.S. companies is equivalent to ignoring one-half of all investment opportunities. The world has changed and your portfolio allocations should reflect the increased global emphasis.