Emerging Markets

In: Business and Management

Submitted By Novaz
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Do Emerging Markets Still Offer Diversification Benefits?
One of the most significant contributions to the investment community has been Markowitz’s modern portfolio theory (MPT) and its foundations in risk return trade-offs and international asset diversification. The growing dependency of Emerging market countries on the US for its stable currency and export sales among other factors has increased their dependence on US markets for their GDP and market growth. This has caused a reduction in the diversification benefits in the Emerging markets. This paper will examine the various empirical evidence on emerging markets diversification and will also construct a portfolio to assess whether investment in these markets still provide benefits.
MPT is based on two key principles of investing, namely that an investor will seek to maximise expected return whilst also minimising risk. Its risk is measured by its standard deviations of returns around expected values. By considering “the expected return of each investment in relation to the impact that it has on the risk of the overall portfolio,” (Litterman (2004) p. 12) An investor can prevent weaknesses in one asset class from reducing the portfolio’s overall return. Therefore a portfolio that is invested in a range of industries or asset classes is more diversified against risks that may affect only one asset class. (Crescenzi (2008) p. 141) The implication is that portfolios are constructed with a rate of return equal to the weighted average rate of return of the holdings and yet its risk will be less than the weighted average return of the portfolio. (Litterman (Ibid) p.14)
Recent developments in Exchange Traded Funds (ETFs) and mutual funds have allowed investors to be invested across a range of markets and countries without being exposed to the potentially large risks of any one internationally traded company.…...

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