As recently as the beginning of last year, many Western institutional investors were debating whether China’s stock market was investible. It was a legitimate question which, to this day, is difficult to answer given the plethora of risks in China.
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It was also a sign that despite dramatic improvements in governance standards, economic fundamentals and the transparency and resilience of financial markets in many developing countries over the past few decades, institutional investors perceive emerging markets as inherently riskier than advanced economies.
This is certainly the case for some emerging markets, especially in Africa and Latin America, that have struggled to reform their economies and are more vulnerable to external shocks. Yet the emerging market asset class as a whole is more mature, more diverse and more investible than it was in the 1990s and early 2000s.
Changes in perceptions of sovereign risk have not kept pace with profound shifts in the global economic and financial landscape. Many fund managers continue to overestimate risks in emerging markets while underestimating threats in advanced economies.
In the aftermath of the 2008 global financial crisis, Jerome Booth, a prominent investor in emerging markets, said he defined “emerging markets by risk perception. Basically, all markets are risky; the emerging markets are the ones where that’s priced in. A developed country is one where that risk is not priced in, is ignored”.
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Booth’s distinction between risks in developing and developed economies is as relevant today as it was back then. While it is debatable whether threats in emerging markets, even some of the most resilient ones, are adequately priced in, Booth was right to point out that investors were too complacent about risks in advanced economies.