Kinnel's Fund Picks for Emerging Markets

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. It's emerging-markets week on Morningstar.com, and joining me to share his best ideas for investing in emerging markets is Russ Kinnel. He is director of fund research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: Russ, there are various avenues that people can take for investing in emerging markets. Let's discuss why someone might want to invest directly in some sort of emerging-markets fund or exchange-traded fund? What are the pros and cons of doing that?

Kinnel: Well, obviously, the case for emerging markets is fairly strong, and it's a tremendous growth engine for the whole world. But if you want to buy a fund dedicated to emerging markets, what's good about it is you know then that part of your portfolio is going to give you emerging-markets exposure. And you don't have to worry about a manager in a more broad fund moving somewhere else and giving up on that.

Benz: You have a little bit of control.

Kinnel: That's right. It gives you a little more control. The downside is that it's more volatile. Emerging markets even though they seem to be a growth engine and you would think many of them have less debt issues than the U.S. and Europe, nonetheless they're very volatile still. When we do this risk-off, risk-on move, emerging markets are always part of that.

You have to be prepared for more volatility; you have to be prepared for the cycles. It can be pretty rough in that you might have three years of losses and then three years of huge gains. You really have to think long term, and you have to be risk-tolerant or you are not going to get the benefits.

Benz:  I know when we look at some of our investor-return data we see that sometimes investors don't time their purchases of emerging markets so well, though they've been buying recently even though performance hasn't been that great.

Kinnel: That's right. You see that reflected in investor returns. People sometimes will give up at the wrong times, and so, I think, in general, even if you're getting a dedicated emerging-markets fund, you might want to look for one that's a little less risky to at least smooth it out some of those extremes.

Benz: You brought couple of ideas for people who want to invest directly in emerging markets. These are funds that you like a lot. The first one is a fund that is not a household name. It's Harding Loevner Emerging Markets. Let's talk about that fund and why you think it's a good pick?

Kinnel: Right. Well, as you say, it's not a household name. That's one good thing in that it doesn't have that much money to manage as opposed to some of the more popular ones. But also I like its approach. It's got a mix of quality, but also emphasis on valuations, so that tends to take you to the less risky part of the emerging markets. [The managers have] done a really good job and have had just good stock selection over the long haul. You've got good long-term risk-adjusted performance, and you have experienced managers. A lot of things you'd look for in any fund you'd find a fund like this, and it's still fairly small with about $3 billion in assets.

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Benz: Another fund, more specialized still, this is from a shop that I know a lot of our Morningstar.com readers like a lot, it's a Matthews fund. Let's talk about what that one is, what it does, and why you think it's a good pick for people who want that more specialized exposure.

Kinnel: Matthews really is dedicated to investing in Asia, and they really have a lot of experts in Asia. I like Matthews Asian Growth & Income for [the managers'] expertise, but also because it has got converts and preferreds as well as stocks, and that tends to tone down a little bit of volatility. Again, you get a little less risk, a little less return. But still that makes for a much more attractive package, and if you look at its 10- and 15-year investor return, they're actually very strong, which tells me it works well for people.

And I think a lot of the biggest emerging markets, of course, are in Asia today, so it makes sense from that perspective, as well.

Benz: How about just indexing emerging markets? That's where we've been seeing a lot of the flows going, people just buying index funds or ETFs versus being in some of the active funds. Do you think that that's a viable way to invest in emerging markets?

Kinnel: What's great about indexing in emerging markets is that most active funds are pretty pricey. You get a really big savings [with indexing]. The downside is, mostly China and Brazil are the biggest markets, and those are pretty volatile. And of course, [index funds] can't do the strategies that Matthews or even Harding Loevner do to reduce volatility. [Indexing is] going to be pretty volatile, but the cost advantage is significant, and that's not bad.

Benz: Let's discuss another avenue for investing in emerging markets, and that's simply buying a broad foreign-stock fund, not owning an emerging-markets-specific fund, but really leaving it up to the manager to make those decisions for you. Let's discuss that the plusses and minuses of an approach like that.

Kinnel: There are a couple. One, you have a foreign fund--and most foreign funds will have some emerging markets, typically 5% to 15%, but some will have more. And one positive is that [the managers] can go in and out [of emerging markets], so they may be able to time that well or buy the ones that they find attractive. Another is that [broad foreign-stock funds are] going to be less volatile than a dedicated emerging-markets fund. If having extreme performance in an individual fund messes up your own psyche, and it is hard for you to hold on to, then a fund like a foreign fund or world stock fund with emerging-markets exposure is a good way to have a little more low-volatility exposure, but they're still buying emerging markets, too.

Benz: You brought a couple of examples of funds that you think are good picks for people who want to go this route with a broad foreign-stock fund that has historically done a good job with emerging markets. Columbia International Growth is one of the funds on your list. What do you like about it?

Kinnel: Columbia Acorn International is a fund I really like. In that, they've a lot in emerging markets, but they do a good job of dishing out responsibility to analysts and managers alike. Each one has a smaller focus, and that seems to have worked really well. It's a smaller-cap, more diffuse portfolio, but it's not so diffuse that it is indexlike. It [has] growth at a reasonable price and a fairly diffuse portfolio, with a really good long-term return profile. And I really like what's been going on there. This year illustrates the downside of having more in emerging markets as emerging markets have lagged developed markets. Therefore, this fund has lagged a little, but I don't think that's really a surprise or really a negative for the fund. Its long-term performance is still strong.

Benz: Is this a fund for people who want to buy; is it best-suited for people who are working with an advisor? It carries a sales charge?

Kinnel: That's right. It used to be no-load, but unless you bought it more than a decade ago, it a load fund, so you have to go through an advisor.

Benz: The other fund on your list that you think exemplifies a good broad foreign-stock fund that has the ability to invest in emerging markets is a no-load one. This is Vanguard International Growth. It's one that I own and have owned for many years. Let's talk about what you think are the big pros here?

Kinnel: Well, of course, [because it's] Vanguard, it's low-cost. And again it's going to be less volatile if you have multiple subadvisors--and they're good subadvisors--but it means you have a more diffuse portfolio because when you have multiple subadvisors that gives you some style diversification and that they're not doing the exact same thing. So, it's not going to be a really exciting fund, but it's going to be easy-to-own. Morningstar has it its 401(k) for that reason. It's low-cost and dependable, but it does have meaningful emerging-markets exposure. So, again, it's a good way of illustrating that you don't have to go direct to emerging markets. Here is a really low-cost way, and a less volatile way, to get that exposure.

Benz: Russ, thank you so much for being here to share these ideas.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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