Explain the risks particular to holding emerging market equities
The idea
Equity investors in emerging markets face governance and institutional risks on top of market volatility. Minority shareholder protection may be weak, ownership is often concentrated in families or the state, and controlling holders can extract value through related-party dealings. Accounting and disclosure standards may be looser, capital controls can restrict repatriation, and political intervention can change the rules for whole sectors. Currency risk adds to return volatility, and liquidity can vanish in stress. In expected return models, lower integration with global markets argues for a higher risk premium, often estimated by blending integrated and segmented Singer–Terhaar premiums. The trap is to treat higher expected growth as higher expected equity return without allowing for dilution and governance.
Formulas
Singer–Terhaar blend for a partly integrated market
RP = φ × integrated RP + (1 − φ) × segmented RP
- φ
- the degree of integration with global markets, from 0 to 1
- integrated RP
- the premium using the market's actual correlation with the global market
- segmented RP
- the premium with that correlation set to one
Emerging markets are only partly integrated, so φ is below one and the blended premium sits above the integrated one. Add an illiquidity premium separately where trading is thin.
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