Most of the new emerging-markets funds can safely be ignored.
The number of emerging funds has been expanding rapidly. More than four dozen diversified emerging-markets funds have been launched in the past three years, in fact, raising the total number of such offerings to 150. In addition, many region-specific funds--China Region, Latin America, and Pacific Asia ex-Japan--have opened over this time span. There now nearly 80 regional emerging-markets offerings.
There are some good reasons for this. The growth rates and overall economic fundamentals have been better in the developing world than the developed world for several years, and those advantages are expected to persist. And the investment and regulatory climates have improved considerably in many developing countries in the 2000s, while the universe of public companies has increased significantly in number and quality.
But there also are ample grounds to believe that many fund companies are engaging in performance chasing: The four categories of emerging-markets funds earned huge gains and crushed all other types of mutual funds in the early 2003 to late 2007 worldwide stock surge, and they've performed similarly well in absolute terms and nearly as well in relative terms since the current equity rally began in March 2009.
The overall quality and attractiveness of the emerging-markets funds launched in recent years leaves something to be desired as well. Indeed, many of the newer diversified emerging-markets funds and nearly all of the regional emerging-markets offerings can safely be ignored.
Not Many Noteworthy Launches in the Diversified Emerging-Markets Group
Diversified emerging-markets funds tend to be attractive than the various categories of regional emerging markets. Because they can invest throughout the developing world, all emerging-markets opportunities are within their purviews and they're fairly diversified by country, sector, and stock. Thus, though they're quite volatile in absolute terms, these funds are the least volatile type of emerging-markets offering, and the easiest for investors to use.
A few of the newer funds, to be fair, do have substantial promise. For example, Northern Multi-Manager Emerging Markets
But many of the newer funds have significant weaknesses. Several of them are pretty pricey, are from mediocre fund families, or are from solid shops without proven emerging-markets expertise. And a number of the rest have other limitations. Marsico is a fine firm, and James Gendelman had added a lot of value at Marsico International Opportunities
Hardly Any Appealing Launches in the Regional Emerging Categories
Regional emerging-markets funds have very narrow appeal by nature. In addition to making many good emerging-markets opportunities off limits, their geographic focus often leads to considerable sector and stock concentration (because the investment universes tend to be rather limited in any one or few emerging markets). And due to all this concentration, these funds are prone to performance extremes, and they should not be used as supplemental international holdings. In fact, they make sense only for risk-tolerant investors who already have a well-balanced portfolio of overseas offering and are seeking an extra bit of foreign spice for the very long haul.
Such investors will find that only a very few of the newer funds have clear merit. Matthews China Dividend
But most of the newer funds have significant weaknesses. Many of them are rather expensive, are from fairly new or unexceptional fund families, or are from firms that have had success in other areas but have yet to demonstrate proficiency in the region or market in question. Meanwhile, some of the newer regional funds exacerbate the limitations--and risks of all such funds--by adding on another level of concentration. Front-load GlobalAfrica Infrastructure
Investors should keep three facts in mind as they consider the greatly expanded universe of emerging-markets funds. First, there are other types of international-stock funds that provide significant exposure to the developing world. Most foreign large-cap funds as well as most foreign small/mid-cap offerings devote to 10% to 20% of their assets to emerging-markets stocks, and many such funds invest even more in such issues. Thus, it's certainly possible to get a sizable stake in the developing world without owning a diversified emerging-markets fund, let alone a regional emerging-markets offering.
Second, while there are fairly slim pickings among the newer emerging-markets funds, there are several good options among the more-established offerings, most notably Morningstar's Fund Analyst Picks. Third, realistic expectations and long time horizons are essential with all emerging-markets funds: The enormous gains that these funds have posted in the surges of the 2000s won't necessarily be repeated in future rallies, and even the tamest diversified emerging-markets funds incur big losses in tough times.