How to Invest in Emerging Market Funds - SmartAsset

Investors with an eye for growing economies can invest in emerging market funds such as a mutual fund and an ETF. Over the past 20 years, investors have found great success in countries such as China and India. These countries have had dramatic growth and investors have reaped exceptional returns buying securities linked to these economies. Here’s where to find emerging market funds and what to look for in such funds.

Sifting through the vast array of emerging market funds can be overwhelming. That’s why getting help from a financial advisor makes a great deal of sense.

What Is an Emerging Market?

In 1981 International Finance Corporation established a new asset class for investors, namely, emerging markets. An emerging market enables trading in assets based in an emerging economy, also known as a developing economy. Definitions of emerging economies vary. Among the most common criteria of emerging markets are those in nations whose gross domestic product is rising sharply and becoming more globally integrated and whose market trading and settlement processes are becoming more sophisticated and transparent.

In addition to such factors, emerging economies are recognized by a growing middle class and rising consumer demand. They also have an increasing labor population. Analysts and investors view these economies as having a high growth potential. Among such economies are Brazil, India and Brazil. China has been an emerging economy but, given its status as the world’s No. 2 economy, it is sometimes left off recent lists of developing economies.

Most of the countries that make up these funds have high growth potential. This makes them potentially profitable investments for those seeking higher-than-average returns.

Emerging Market Funds

Emerging market funds resemble those focused on the developed world. They can be mutual or exchange-traded, focus on a specific country or a global region and offer holdings that are equity, debt or a blend of those two, commodities and the domestic currency. Investors can select passive or active funds linked to emerging or developing markets.

One distinctive of emerging market funds is their higher expense ratio. That stems from the greater difficulty in gathering reliable economic and financial information about a country and corporations based in that country.

A number of indexes have become established to help retail investors gauge the suitability of specific choices. They include Bloomberg Barclays Emerging Market Aggregate Index, the J.P. Morgan Emerging Markets Bond Index, MSCI Emerging Markets Index and the S&P Emerging Markets Broad Market Index.

Emerging Market Fund Risks

While emerging market funds offer the opportunity for greater returns than those in developed markets, there is often an increased risk. Also, these funds may be prone to more volatility than developed markets. Because the markets are smaller, they may be more vulnerable to things such as political shifts or changes to monetary policies.

Additionally, emerging market funds often have currency risk. This means that the value of the security can fluctuate because of several variables. These variables can include the increase or decrease to the security price and also the currency relative to the dollar. When determining if you should invest in an emerging market fund, it’s important to weigh the advantages and disadvantages of a fund. Specifically, consider funds that hedge currency risk in comparison to ones that yield currency exposure.

How to Invest in Emerging Markets

If you’re interested in investing in emerging markets, there is a variety of ways you can do so. Understanding the different investing environments can help investors select the right emerging market fund and sector. Here are some of the environments you can expect to invest in, when working with emerging markets.

Investing directly in an emerging market fund: Directly investing in an emerging market fund is nearly impossible. Many brokers don’t offer direct investments on international stock exchanges. Those that do, may only offer direct investments to developed markets. However, global or international funds that invest in both emerging markets and non-U.S. developed markets are another option. As emerging market funds evolve, investors can expect an increase in opportunities of direct investment. For the time being, alternative investments such as emerging market stocks may be your only option.
Investing in emerging market stocks on the U.S. stock exchange: There are hundreds of emerging market firms that trade on U.S. stock exchanges such as the Nasdaq or the New York Stock Exchange. The advantage of investing in an emerging market stock is that in order to have a listing on a U.S. exchange, companies must provide financial disclosure. This gives the stock more transparency. Additionally, listed companies tend to be more established in their designated markets.
Investing in emerging market ETFs: There are numerous ETFs that solely focus on emerging markets. Some emerging market ETFs focus on a variety of countries; others focus on specific countries or specific sectors of emerging market stocks. Before you invest in an emerging market ETF, make sure you understand how the fund defines emerging markets. Be certain you know how they select assets, what fees you can expect and how the fund manages its holdings.
Investing in U.S. stocks that do business in emerging markets. Investors who are leery of investing in emerging market stocks or ETFs can invest in companies that do business in emerging markets. Many large companies that are in the consumer goods industry often find new markets for their products in countries with emerging economies. For example, Las Vegas Sands operates the Venetian and Palazzo casino resorts in Las Vegas. But it has an even larger presence in the Asian gaming capital of Macau, where a majority of the company’s profits come from.

What to Look for Before Investing

Similar to any other investment, it’s crucial to determine how an emerging market fund will fit into your overall portfolio. Particularly, you will want to ensure that your asset allocation coincides with your investment horizon and risk tolerance.

It’s also important to consider whether your other investments already have emerging market exposure. An example of other investments with market exposure are global funds. These will include emerging markets in their allocation. Also, note well that many large corporations often derive profit from emerging markets. Therefore, take the time to review your portfolio and make sure your total allocation makes sense for achieving your financial goals and objectives.

The Bottom Line

While emerging market funds can be risky, the reward investors have the potential to receive may be worth the risk. Your desired level of management and your short-term and long-term investment goals will help you determine if this is a suitable investment for your portfolio.

Tips for Choosing Investments

A financial advisor can help with identifying and reaching goals, as well as taking on much of the work. If you don’t have a financial advisor yet, finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Consider how soon you want your money back. If you’re saving for the short-term, like for a down payment on a residence, an investment like a mutual fund may not be right for you.
Be aware of the fees and charges involved. As is the case with an ETF vs. mutual fund, trading and management fees vary, as does tax efficiency.