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By Paul Justice, CFA | 03-30-2011 04:47 PM

Roadmap for Emerging-Markets ETFs

Morningstar's Patty Oey on the makeup of the biggest emerging-markets exchange-traded funds, some of the major trends driving those markets today, plus two ways to play South Korea.

Paul Justice: Hi, there. I'm Paul Justice, director of North American ETF research at Morningstar.

I am here today to talk about emerging-market funds and the incredible growth that they have realized over the last several years. More people are choosing ETFs to gain their emerging-market exposure than they would, say, with their large-cap domestic equity exposure, even though those funds are much larger on a net asset basis.

On a percentage basis, emerging-market funds are extremely popular in the ETF space. 35% of the time, people are choosing an ETF to gain that exposure for a diversified emerging-market fund, and when they go into regional exposure, single country funds, that number grows to more than half the time that they will choose an ETF over a mutual fund.

Today to talk about this with me is Patty Oey, our emerging markets and foreign country ETF specialist.

Patty, thanks for joining me.

Patricia Oey: Thanks, Paul.

Justice: So there's been a ton of interest in emerging-market funds in general. Could you talk a little bit about the performance of emerging markets over the last several years and possibly why you think that's happening?

Oey: Well, in 2009, the emerging markets performed very strongly. They were up about 70%, and then last year they outperformed the S&P slightly, but so far this year in 2011, they are underperforming. They've spent most of the time in the red.

The main issue there is inflation. Inflation has picked up starting at the end of 2010, and a lot of developing-country central banks have begun a round of tightening, and this is expected to weigh on growth in the near term.

More recently, the political instability in the Middle East has also reduced investors' appetite for risk.

Justice: Now, when you're getting a diversified emerging-market fund--two of the four largest ETFs on the market today both follow the MSCI Emerging Markets Index: the Vanguard VWO, and the iShares EEM funds, with about $90 billion in assets each. You're getting exposure to a lot of different places. Could you talk about how many countries are represented by those and where some of the heavier weightings might be?

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