What Is a Developing Country?
Developing Country Classifications for Investors
International investors often classify countries around the world based on their level of economic development. Several classification levels exist, and these classifications use a number of economic and social criteria, ranging from per capita income to life expectancy to literacy rates. Developing countries, less-developed countries (LDCs), or emerging markets are those with lower ratings based on these statistical criteria.
Countries deemed more developed than LDCs are called developed countries, while those less developed are known as less economically developed countries (LEDCs) or frontier markets. While these terms have been the subject of criticism, they remain commonly used in many circles, including among international investors and international organizations.
Developing countries sit just below "developed countries" and above "less economically developed countries." Developed countries are countries with economies that have high growth and security when looking at the gross domestic product per capita income, and general standard of living, among other factors. Examples include the United States and Western Europe.
Less economically developed countries (LEDCs) are countries that exhibit the lowest indicators of socioeconomic development. According to United Nations standards, these countries have low incomes, human resource weaknesses, and economic vulnerabilities that include weak natural resources or population displacement.
As a result, these tend to be riskier investments, as there's a much higher level of uncertainty, however, they may be suitable for a well-diversified portfolio.
Measuring a Country's Development
Institutions measure a country's development in many ways, and it's not an exact science. While the United Nations has few conventions for distinguishing between "developed" and "developing" countries, the World Bank makes specific distinctions using gross national income (GNI) per capita, and other analytical tools as additional benchmarks.
The International Monetary Fund's (IMF) definition is often considered to be the most comprehensive measure, as it takes into account per capita income, export diversification, and the degree of integration into the global financial system.
In 2011, the organization published a research report on the topic of development classification titled "Classification of Countries Based on Their Level of Development" that outlines its methodologies for classifying a country's level of development.
The World Bank has a much more concrete methodology, as it considers countries with a per capita income of less than $12,275 as "developing" countries. But the organization also divides these developing countries into numerous income classes, ranging from low-income to upper-middle-income countries, meaning there are other gray areas for international investors to consider.
Typically Recognized Developing Countries
Various organizations use different measures to determine how companies are classified, but a few common denominators appear in the mix. For instance, Brazil, Russia, India, China, and South Africa (BRICS) are generally considered developing countries, but examples of common developing countries go far beyond these popular emerging markets.
Other countries that appear on most lists of developing countries include:
- The Philippines
Investing in Developing Countries
You can invest in developing countries easily with exchange-traded funds (ETFs) focused on emerging markets. While these investments aren't as safe as those in developed countries because of their volatility, they tend to have higher rates of return over the long-term, simply because developing economies often grow at a faster rate than developed ones.
This makes them an important component of an investor's portfolio, particularly if they have a long-term horizon.
A secondary benefit of these emerging markets is diversification, which spreads out investment risk so that exposure to any single asset is limited. Emerging markets provide investors with diversification from both domestic and developed market equities that tend to account for most of a portfolio.
For example, the iShares MSCI Emerging Markets ETF (EEM) has a correlation coefficient of just 0.5619 compared to the SPDR S&P 500 ETF (SPY) between January 2004 and July 2017.
Some popular emerging-market ETFs include:
- iShares MSCI Emerging Market Index ETF (EEM)
- Vanguard MSCI Emerging Markets ETF (VWO)
- BLDRS Emerging Markets 50 ADR Index ETF (ADRE)
- SPDR S&P Emerging Markets ETF (GMM)
Alternatively, investors can purchase American Depository Receipts (ADRs) trading on U.S. exchanges to easily gain exposure to specific companies within these developing countries. Keeping a diverse portfolio across multiple developing countries can provide a great, diversified portfolio of international opportunities.
Those seeking even more specific returns can also consider purchasing stock on foreign stock exchanges, although this entails some unique taxation and regulatory risks.
The Bottom Line
Investors like to use classification systems in order to simplify the investment process. When it comes to regions of the world, developing countries have not quite reached maturity, although there's a wide array of different definitions. International investors may want to be cognizant of these different criteria when evaluating the risk and return potential of their portfolio.