Political Risk of Investing in Emerging Markets
The weekend failed coup in Turkey reminded global investors once again that investing in emerging markets is a risky business. On last Friday, July 15, the news of attempted military takeover sent currencies of emerging markets, especially Turkey's lira tumbling against US dollars, Euros and Japanese Yen. At one point, my friend in Turkey told me that it took 5 liras to buy 1 US dollar. Along with falling currency, Turkey's shares trading overseas went down as well (Per the chart from MarketWatch.com)
Over the weekend and till this Monday morning, when it became clear that the military coup failed, most Asian markets traded slightly up. Major indices in the U.S. currently shows slight gains as well.
Investors shouldn't take their funds out in emerging markets because of event like this. After all, it's estimated that close to 70% of world economic growth has come and will continue coming from emerging markets. The valuations of emerging markets equities are much cheaper compared to their peers in developed markets, so there's potential for higher returns. For most investors, there's a place in their portfolios to hold some investments in emerging markets if they have a long investment time horizon.
But the failed coup in Turkey is a reminder that political risk plays a much bigger role in emerging economies. Higher probability of political risk increases market volatility. So if you want to have some exposure to emerging markets, make sure you take only the level of risk you are comfortable with.