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Blurred Lines for Funds a Mixed Blessing for Investors

Pushing against borders allows more freedom and choice but complicates selection and evaluation.

Gregg Wolper, 03/11/2014

I'm not referring to "tactical" funds, which allow themselves the freedom to own almost anything and to change direction rapidly; they can be grouped with other like-minded rivals. Rather, I'm referring to funds that do have constraints, but which are redefining those boundaries.

The resulting flexibility has the advantage of allowing their managers more freedom to buy the securities they consider most appealing. But funds that adjust the boundaries can complicate the task of building a portfolio, especially for investors who favor specific asset-allocation targets or are simply trying to get straightforward exposure to a type of asset they currently lack.

The Emerging-Markets Menu Expands
Perhaps the clearest example of this phenomenon can be found in the emerging-markets realm. Twenty years ago, emerging-markets stock funds either looked at all emerging markets around the world or focused on a single country or region. Emerging-markets bond funds owned dollar-denominated government debt, for the most part. It was generally considered too risky to own bonds issued by emerging-markets companies rather than by governments, or to own either type of security denominated in local currencies, if enough such bonds could even be found.

But the emerging-markets landscape gradually has become much more varied. Lazard, Dreyfus, and other firms have assembled portfolios that combine emerging-markets stocks with emerging-markets bonds and other assets. Other funds (such as veteran American Funds New World NEWFX, around since 1999, and Thornburg Developing World THDAX, which appeared 10 years later) concentrate on emerging-markets stocks but also include many firms based in the United States, Europe, or other developed markets that have substantial emerging-markets exposure.

Meanwhile, among dedicated fixed-income offerings, a number of funds now buy emerging-markets bonds issued in local currencies rather than in dollars or euros, and debt from emerging-markets companies is no longer off-limits. Many funds, in fact, focus particularly on local-currency debt, such as PIMCO Emerging Local BondPELBX, while TCW Emerging Markets Income TGEIX is one of the few that puts all of these varieties in the same portfolio.

The innovations didn't stop there. As the biggest emerging markets, such as Brazil, China, and South Korea, grew and matured, a few intrepid souls started looking to so-called frontier markets such as Kuwait and Nigeria, whose stock markets are considered to be a step below emerging status. And fund companies weren't content to simply create frontier-markets funds and leave it at that. Several (including Harding Loevner Frontier Emerging Markets HLFMX and Wasatch Frontier Emerging Small Countries WAFMX) decided to blur the line and create portfolios that combine stocks from frontier markets with those from smaller emerging markets.

Worth a Look?
Although investors should be wary of new fund types--many trendy but unwise fund ideas have come and gone over the years--some of these rest on a reasonable footing. 

For example, there can be merit in including developed-markets companies with a broad presence in developing countries in an emerging-markets portfolio. While some emerging-markets firms dominate their local markets, in other areas multinationals such as Unilever UL or Nestle or McDonald's MCD also reap tremendous benefits from the rising incomes and increased consumer and infrastructure spending in rapidly developing parts of the world. Moreover, such a portfolio can exhibit less volatility than a pure emerging-markets stock fund, making it more likely that shareholders will hold on when stock markets shudder.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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