What Is Blend Countries?
The term "blend countries" is not a formal, standardized financial designation, but rather refers to the strategic inclusion of various country classifications—such as developed markets, emerging markets, and frontier markets—within an investment portfolio. This approach falls under the broader financial category of global market classification and portfolio management. By intentionally combining investments across countries at different stages of economic and market development, investors aim to achieve enhanced diversification and optimize their risk-return tradeoff.
History and Origin
The concept of classifying global equity markets into distinct categories emerged with the rise of international investing. As investment opportunities expanded beyond domestic borders, the need for systematic categorization became apparent for benchmarking and portfolio construction. Major index providers, such as MSCI and FTSE Russell, developed comprehensive frameworks to classify countries based on criteria like economic development, market size, and accessibility for international investors.
MSCI, for instance, has been classifying markets for decades, continually refining its methodology to reflect evolving global capital markets and investor practices. Their framework considers factors like economic development, size and liquidity requirements, and market accessibility, which includes aspects such as foreign ownership limits and foreign exchange repatriation. Si6milarly, FTSE Russell employs its own rigorous annual review process, categorizing markets as Developed, Advanced Emerging, Secondary Emerging, or Frontier based on a range of criteria developed in conjunction with international investors. Th5ese classification systems are dynamic, with countries regularly reviewed and sometimes reclassified as their markets evolve. For example, the MSCI 2023 Market Classification Review introduced methodology changes for Frontier Markets.
#4# Key Takeaways
- "Blend countries" refers to the practice of constructing investment portfolios that include exposure to different country classifications (developed, emerging, frontier markets).
- Major index providers like MSCI and FTSE Russell classify countries based on economic development, market size, and accessibility.
- The goal of blending country exposures is to enhance diversification and potentially improve risk-adjusted returns.
- This approach requires understanding the unique risk and return characteristics of each market type.
Interpreting the Blend Countries Approach
Interpreting the "blend countries" approach involves understanding the rationale behind combining different market types in an investment strategy. Investors adopting this approach recognize that each country classification offers distinct characteristics. Developed markets, for example, typically provide stability and lower volatility, while emerging markets may offer higher growth potential but come with increased risk due to factors like political instability or currency fluctuations. Frontier markets, being the least developed, can offer even higher growth prospects and potentially lower correlations with other markets, but also entail significant liquidity and regulatory risks.
By combining these segments, an investor aims to capture the growth opportunities from developing economies while maintaining a foundational exposure to the stability of developed economies. The specific allocation to each segment in an asset allocation strategy depends on the investor's risk tolerance, investment horizon, and objectives.
Hypothetical Example
Consider an investor constructing a global equity portfolio of $100,000. Instead of investing solely in their home country or in other developed markets, they decide to "blend countries" to enhance their diversification and seek broader growth opportunities.
They might allocate their portfolio as follows:
- 60% Developed Markets: $60,000 invested in a broad market index fund tracking countries like the United States, Japan, and Germany. This provides a stable core.
- 30% Emerging Markets: $30,000 allocated to an emerging market exchange-traded fund (ETF) with exposure to countries such as China, India, and Brazil. This introduces higher growth potential.
- 10% Frontier Markets: $10,000 placed in a frontier market fund investing in less developed economies like Vietnam or Romania. This adds a component with potentially uncorrelated returns and long-term growth prospects, albeit with higher liquidity risks.
This hypothetical blend aims to balance the stability of mature economies with the potential for higher returns from rapidly developing ones, diversifying risk across different economic cycles and geopolitical landscapes.
Practical Applications
The "blend countries" approach is a fundamental component of modern international investing and asset allocation strategies. Investors, from large institutional funds to individual retail investors, apply this concept to achieve various objectives.
One primary application is in building globally diversified mutual funds and exchange-traded funds (ETFs) that offer exposure to multiple country classifications within a single product. These funds often track broad global indexes that inherently include a blend of developed, emerging, and sometimes frontier market equities or fixed income securities. For example, an actively managed global equity fund might deliberately overweight certain emerging markets based on their growth outlook while maintaining a core holding in developed markets.
Another application is in risk management. By spreading investments across various country types, investors can mitigate the impact of adverse economic or political events in any single region. Regulatory bodies and investment advisors often highlight the importance of geographical diversification as a means to manage portfolio risk. The International Monetary Fund (IMF), for instance, provides analyses on emerging market economies, emphasizing their growing role in the global economy and the associated investment considerations [https://www.imf.org/en/About/Factsheets/Sheets/2023/emerging-market-economies].
Limitations and Criticisms
While blending country exposures offers significant diversification benefits, it is not without limitations or criticisms. One challenge lies in the dynamic nature of market classifications themselves. A country can be upgraded or downgraded between classifications by index providers based on evolving criteria, which can lead to shifts in index composition and necessitate portfolio rebalancing. For example, FTSE Russell announced in 2018 that Poland was reclassified from Advanced Emerging to Developed market status. Su3ch reclassifications can trigger significant capital flows as funds tracking specific indices adjust their holdings.
Another limitation is the inherent complexity and increased due diligence required when investing in less developed markets. Frontier markets often suffer from lower liquidity, less transparent regulatory environments, and higher political or economic volatility. Even within emerging markets, varying levels of market accessibility and regulatory hurdles can impact foreign investment. For instance, FTSE Russell noted that progress in Vietnam's reclassification to Secondary Emerging status has been slower than anticipated, partly due to the settlement cycle and account registration processes. Th2ese factors can lead to higher transaction costs, greater price swings, and challenges in capital repatriation.
Furthermore, correlations between different market types can increase during periods of global stress, reducing the expected diversification benefits. Economic crises or geopolitical events can sometimes lead to a "flight to safety," where investors pull capital from riskier developing markets simultaneously, causing them to move in unison despite their distinct characteristics.
Blend Countries vs. Market Classification
"Blend countries" refers to an investment strategy focused on combining exposures to different country classifications within a portfolio. Market classification, on the other hand, is the system used by index providers like MSCI and FTSE Russell to categorize countries into groups such as Developed, Emerging, and Frontier based on predefined criteria.
The key distinction is that market classification is a descriptive framework, while "blend countries" describes an active approach to asset allocation that leverages this classification. Investors use the results of market classification to inform their decision to "blend" their exposure across these various categories, seeking to optimize their global investment portfolio. The former defines the categories; the latter is a method of investing across them.
FAQs
What are the main country classifications in investing?
The main country classifications used by global index providers are Developed Markets, Emerging Markets, and Frontier Markets. These categories differentiate countries based on their economic development, market size, and the accessibility of their capital markets to foreign investors.
Why do investors blend investments across different countries?
Investors blend investments across different countries primarily for diversification. This strategy aims to reduce overall portfolio risk by spreading investments across various economies and market cycles, and to potentially enhance returns by capturing growth opportunities from various regions.
Are "blend countries" riskier than investing in just one type of market?
A "blend countries" approach typically aims to balance risk. While including emerging markets and frontier markets introduces higher individual country risks (like volatility and liquidity issues), combining them with stable developed markets can lead to lower overall portfolio risk than concentrating solely in any single market type.
How often do countries change their classification?
Country classifications are typically reviewed annually by major index providers like MSCI and FTSE Russell. Changes are usually announced in advance to allow investors to adjust their portfolios. These reclassifications depend on a country's ongoing economic development, market reforms, and adherence to specific criteria set by the index providers.1