Morningstar's Best Ideas for Emerging-Markets Exposure

With slowing growth and falling commodity prices, emerging markets are at the epicenter of the current market volatility. So, why give them a look right now?

They could be cheap, that's why.

Not-inexpensive stock valuations stateside have likely contributed to recent U.S. market volatility, and several market experts think emerging markets now look cheap relative to developed-markets stocks in the U.S. and Europe. For example, the researchers at both GMO and Research Affiliates would likely concede that they were early in emphasizing emerging markets, but they're standing by the assertion that there's money to be made by venturing into them. Both also maintain that emerging-markets bonds should far outpace developed-markets bonds in the years ahead.

Investors who place little stock in market predictions but instead rely on the tried and true portfolio-management technique of buy, hold, and rebalance may well see signs pointing to emerging markets as well. After all, the typical emerging-markets mutual fund posted a 7% loss during the five-year period through Jan. 15, 2016, during which time the S&P 500 gained 10%. Investors who haven't reallocated during that period are apt to find their portfolios light on foreign stocks in general, and especially emerging markets.

Yet, investing in emerging markets requires a few decisions along the way. A crucial one is just how much emerging-markets exposure is enough. For a little perspective, the market value of all emerging-markets stocks totals about 8% of the globe's equity-market capitalization currently. Thus, a crucial first step for any would-be investors in emerging markets is to check their existing exposures: Those with good-quality broad foreign-stock funds may have ample emerging-markets exposure already.

That "current-exposures check" is also valuable for bond-fund investors who find themselves tantalized by emerging-markets bonds' rich yields and what could be bargain prices today: Core bond funds, and certainly world-bond funds, may also have exposure to emerging-markets bonds.

For investors who decide to move forward into emerging markets, either equities or bonds, the next question is whether to pursue that exposure via a broadly diversified foreign-stock or world-bond fund or one that maintains a consistent emphasis on emerging markets. In general, more broadly diversified funds are apt to be less volatile and easier to own, but investors in them won't be able to avail themselves of the same rebalancing opportunities that can emerge for holders of discrete developed- and developing-markets stock and bond funds.

Either route is defensible, so here are some of Morningstar's best ideas for direct and indirect emerging-markets exposure, both stock and bond.

Emerging-Markets Equity: The Focused Take

," that diversification has also arguably made the fund easier to own than many emerging-markets equity offerings.

For more traditional, pure emerging-markets equity exposure, Morningstar senior analyst Bill Rocco calls out Silver-rated

Of course, an index fund, whether traditional or exchange-traded fund, is often the lowest-cost choice for investors seeking pure-play exposure to a given market segment. But as senior analyst Patricia Oey cautions in this video, one of the most popular emerging-markets index funds,

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to see all of Morningstar's diversified emerging-markets medalist funds.

Emerging-Markets Equity: The Diversified Take

For investors seeking emerging-markets exposure via a broad foreign-stock fund with the latitude to overweight or downplay those markets, Morningstar's Rocco believes Silver-rated

Premium Members can see Morningstar's diversified foreign small- and mid-cap medalist funds

, and its large-cap foreign-stock medalists

. Note that these funds vary widely in their degree of emerging-markets exposure.

Emerging-Markets Bond: The Focused Take Despite attractive yields today, would-be investors in emerging-markets bond funds might find themselves scratching their heads. That's because the emerging-markets bond category is a varied and confusing group, as senior analyst Karin Anderson discusses in this video. Funds take different approaches to their currency exposures, as well as whether they emphasize corporate or sovereign debt.

Anderson notes that

Premium Members can see a complete list of world- and emerging-markets bond medalists

.

Emerging-Markets Bond: The Diversified Take

For bond investors seeking indirect exposure to emerging-markets bonds, Anderson recommends

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.