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With many developed markets currently stalling out in slow-growth mode and struggling beneath the weight of massive deficits, investors have looked to emerging markets for their better growth rates as well as the balance-sheet strength of many emerging-markets economies. Those fundamental factors, combined with the fact that these markets have dramatically outpaced developed foreign markets as well as the United States during the past decade, have stoked investors' appetite for all things emerging. Assets in conventional diversified emerging-markets mutual funds have doubled during the past two years, to nearly $220 billion, while diversified emerging-markets exchange-traded funds have raked in about $40 billion during the past year alone.
Morningstar.com users have been part of that trend, if the recent conversation on Morningstar.com's Discuss boards is any guide. Although some investors have been content to obtain developing-markets exposure via their diversified foreign investments, many others have opted for direct exposure via dedicated emerging-markets vehicles. Still others have opted for region-specific offerings, emerging-markets and world-bond funds, and multinational firms that stand to benefit from future growth in emerging markets. The complete thread, posted in the Portfolio Design/Management forum of Morningstar.com, also includes some fascinating comments about whether the term "emerging markets" has outlived its useful life. Click here to read the complete discussion or add a comment of your own.
The Delegators
A small smattering of posters noted that they like to delegate their emerging-markets decision-making to active managers.
JMikeK spoke up for the delegator approach with this post. "I currently gain foreign and emerging-markets exposure mostly through three world-allocation funds and one world-stock fund: BlackRock Global Allocation (NASDAQ:MDLOX - News), First Eagle Global (NASDAQ:SGENX - News), Ivy Asset Strategy (NASDAQ:WASAX - News), and Jubak Global Equity (NASDAQ:JUBAX - News). I believe this gives me the best return at lower risk. Also, I don't have to worry about country weight."
Several other posters noted that they obtain emerging-markets exposure via broadly diversified offerings as well as targeted emerging-markets exposure. Dtconroe shared this approach: "In general, I prefer to get my emerging-markets exposure as part of a more diversified world-allocation, world-stock, or world-bond fund. I will supplement that diversified fund with a more focused fund when I want more emerging-markets exposure. For example, I own Templeton Global Bond (NASDAQ:TPINX - News), but I added the DoubleLine Emerging Markets Fixed Income (NASDAQ:DBLEX - News) recently to get a little more focused emerging-markets bond exposure."
Ditto for artsdoc, who keeps emerging-markets exposure within tight parameters by using both diversified funds as well as those focusing on emerging markets. "My investment policy statement represents a commitment to emerging-markets investment which is very specific. One third of my equity allocation is international, and one third of that international allocation is in emerging markets. I only use low-cost funds: Vanguard Total International (NASDAQ:VGTSX - News) is the largest of my international holdings. In order to reach my 33% allocation to emerging markets, I supplement that with Vanguard's Emerging Market ETF (NYSEArca:VWO - News). I round out my international asset allocation with Vanguard's FTSE All-World ex-US Small Cap ETF (NYSEArca:VSS - News). I use Morningstar's Portfolio tracker and Style Box to help maintain my allocations."
The core and explore approach also appeals to Chief K, who obtains emerging-markets exposure via index and active offerings. "I hold two Vanguard foreign funds ( Tax-Managed International (NASDAQ:VTMNX - News) in my taxable assets and Total International Index in my IRA assets). They have very similar makeup--emerging markets are only a relatively small portion of their holdings. Both have the same 'story'--buy a low-cost index fund, and you'll get average returns at less than average expenses.
"I also hold American Funds New World (NASDAQ:NEWFX - News): The fund 'story' is that the managers buy mostly stock in developed-markets companies, plus some in emerging markets. But the companies in developed markets must earn significant income from emerging markets. I like the theory of mixing developed-markets regulation and financial/political stability along with the buzz of emerging-markets growth."
FidlStix also mixes direct emerging-markets exposure with broadly diversified investments. "I have three routes to emerging funds: one indirect, through domestic funds holding stocks that invest heavily in emerging markets; a more direct route through international funds with minority holdings in emerging markets; and a direct route, an ETF holding emerging-markets bonds."
Focused Exposure
Other posters noted that they prefer focused emerging-markets exposure.
Poster Aalan88 questions the value of opting for a diversified fund and letting the chips fall where the may, noting, "First, let's look at some performance. I compared SPDR S&P 500 (NYSEArca:SPY - News), iShares MSCI EAFE Index (NYSEArca:EFA - News), and iShares Emerging Markets Index (NYSEArca:EEM - News) as proxies for U.S., international, and emerging-markets funds. (Yes, some funds might outperform the index, but most do not). Since 2003, SPDR S&P 500 is up 67%, iShares MSCI EAFE is up 120%, and iShares Emerging Markets is up 360%. Obviously, portfolios that only started with 'market weight' in emerging markets didn't do nearly as well as those that were overweight; and the recommended 'diversified international funds' almost universally hold close to market weight."
Darwinian also prefers dedicated emerging-markets vehicles, stating the following parameters. "One, I use dedicated emerging-markets funds, so I can take advantage of the violent swings in this volatile asset class to obtain rebalancing profits. Two, I avoid index funds because they have a natural tendency to chase bubbles, overweighting countries with excessive market valuations. Three, I prefer value funds for the same reason. Four, I avoid funds with high commitments to Russia and China because these countries have no laws or moral codes motivating them to deal honestly with foreign investors."
Juris2 concurred that it pays to be selective about Brazil, Russia, India, and China. "I like to visit emerging markets (such as the BRIC countries). But I won't buy Russia until I'm convinced a rule-of-law regime is well-established, for property rights in particular. I have more confidence in Brazil, India, and China as investment targets than Russia, and I now have modest investments in mutual funds with major foci on Brazil and China-- but none in India. My general large-cap international equities fund (about 25% of my overall equity investment) has about 20% exposure to emerging markets. I'm content to stand pat at this time: I have about 8% emerging-markets equities."
Beyond Emerging-Markets Stocks
Rather than focusing on emerging-markets equities, several posters noted that they'd prefer to obtain emerging-markets exposure via other avenues.
Closer, and several other posters, likes the risk/reward profile that emerging-markets bonds have delivered. "During the past decade, I've harvested impressive gains from emerging-markets equity funds. Today, I have very little exposure to emerging-markets stocks. I have chosen to get most of my exposure to emerging-markets through their debt bonds. Why? In his first stint at PIMCO, Mohamed El-Erian was considered the world's most influential emerging-markets bond trader. At that time (in the early 2000s), he told Morningstar that emerging-markets debt bonds captured part of the growth of emerging markets without all of the risks associated with equities. I took that to heart and over the long term El-Erian's advice has worked well for me. I've avoided the volatility of equity funds, been amply compensated by higher yield, and enjoyed capital appreciation, as well. I pair TCW Emerging Markets Income (NASDAQ:TGEIX - News) and DoubleLine Emerging Markets Fixed Income at a 2-to-1 ratio."
Rather than buying emerging-markets equities or bonds straight up, several posters noted that they're taking a less direct route.
For example, poster mitchelg wrote, "I prefer to own U.S.-based multinational companies that derive decent revenue in emerging-markets countries. McDonald's (NYSE:MCD - News) is opening 700 stores in China."
Agenbite is also using the indirect method, noting, "I have been investing in emerging markets mostly via ETFs which hold foreign and U.S. companies that sell hard assets, with Market Vectors RVE Hard Assets (NYSEArca:HAP - News) being a great example. I truly do buy into the theme based on ever-increasing global demand for hard assets." Agenbite has also been dabbling in multinationals that stand to benefit from emerging-markets growth, including Yum Brands (NYSE:YUM - News), General Dynamics (NYSE:GD - News), and Apple (NasdaqGS:AAPL - News).
How to Buy (and When to Sell)
In addition to discussing their favored vehicles for emerging-markets exposure, posters also discussed how to buy into--and when to scale back on--this notoriously volatile market segment.
Darwinian, an asset-allocation enthusiast if ever there was one, shared the following approach. "I bought into emerging markets gradually, when I started setting up my portfolio nearly four years ago, because it appeared to be overpriced; so I did not reach my full target allocation (10%) until January 2009, just at about the market bottom. I allowed my allocation to rise well above my target, as this asset class doubled in value in 2009, but I then began selling down gradually to return to target. I hadn't quite completed this when emerging-markets began dropping this spring, so I am no longer selling, but I'm waiting to see if it recovers."
Aalan88 advocates in favor of a hands-on, tactical approach to emerging markets, writing, "It can be argued that emerging markets are riskier now that they have run up so far, so it's dangerous to overweight them. That's the beauty of ETF investing. After a period of outperformance--or, for people who use tactical allocation, whenever the charts turn bearish--there's no difficulty in reducing the weight of a position, or even shorting it. You just have to pay attention."
RetiredInvestor believes it's time to step off the gas, noting, "My comfort at this point with emerging-markets potential versus risk is limited as is my exposure to this space as a part of my overall portfolio. I have not added to my exposure in the last 60-90 days."
But FidlStix's story illustrates that buying and selling emerging markets can be tricky business indeed. "Several years ago, when I was still earning my chops as an investor, I made a classic mistake: I bought an emerging-markets stock fund that had been roaring up with the rest of that sector. I bought at the top of the ascent, then watched in dismay as the sector and my carefully chosen fund went into a near-death spiral. Next, I made another classic error: I held the fund until my stake had dropped to half its value, then sold low--very low. Finally, I watched in disgust as the market and the fund began to recover. Money lost, lesson gained!"
'Prudent and Practical'
The thread also featured some interesting opinions about the long-term attractiveness of the sector.
Grasul wrote, "One of the very important themes for the future being missed by investors relying on past performance and correlations is the risk premiums for political and currency risk have shifted, and with responsible due diligence, many emerging countries have less political and currency risk than developed nations. But market participants haven't realized it, which makes valuations attractive. My approach is to buy as much emerging-markets exposure as is prudent and practical when it is available at reasonable valuations."
Aalan88 agreed, but countered that massive asset inflows into emerging markets have the potential to jack up risk. "Now that investors have easier access to these markets, there's the hot money risk, which increases volatility. For example: the risk in Russia isn't so much, in my opinion, that the government might confiscate private assets as it is that when the price of oil drops by a dime, all the U.S. investors sell Market Vectors Russ (NYSEArca:RSX - News) at the same time, and the market drops by 15% overnight. Countries that have more domestic investors, like Korea or even Chile, are not so bad."
Chang, meanwhile, added nuance to the discussion, stating that current definition of what's an emerging market ought to change with the times. (I urge you to read the complete thread.) "Many emerging-markets countries have large foreign currency reserves and well-capitalized banks that avoided the toxic securities which plunged the U.S. financial system into crisis. Indeed, it was Iceland--one of Europe's wealthiest countries--whose banking system collapsed in October '08 when the government nationalized its banks. The Icelandic krona lost 75% of its value against the euro--before it ceased to be traded and accepted by foreign banks. Ironically, Iceland turned to Russia for aid to avoid national bankruptcy.
"With many emerging-markets funds invested in Singapore, Taiwan, South Korea, Israel, and Poland, while so-called diversified foreign funds are brimming with the companies of Portugal, Spain, Greece, Italy, and Ireland, what exactly is the distinction that characterizes emerging-markets funds?
Bottom line: Investors shouldn't hew to rigid and arbitrary rules, such as 'My AA has a 10% allocation to emerging markets.' And perhaps investors should avoid funds which likewise employ rigid and arbitrary guidelines."
View the original article here
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