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3rd Quarter 2017

Investing Spotlight: Q&A on Emerging-Markets Funds

You may have heard about emerging-markets funds or seen them offered in your retirement investments. It's important to know what they invest in and whether they should have a place in your portfolio.

What is an emerging-markets fund? How is this different from an international fund? Emerging-markets funds are international investments that focus primarily on developing countries. Emerging markets typically have less stable and established political and economic systems, but are progressing toward becoming developed countries. The major emerging markets now are China, India, Brazil, Russia, and South Africa. International funds invest outside the United States, which can add important diversity to your portfolio because sometimes the stock markets in other countries do well when the U.S. market struggles. International funds often invest primarily in companies in large, developed markets such as Canada, Japan, Australia and many countries in Europe. These markets have a lot in common with the U.S. stock market: the countries tend to have stable and established governments, legal infrastructures, accounting rules, and currencies.

Why would I want to invest in an emerging-markets fund? Having some money in these investments may help diversify your portfolio and give you the opportunity to benefit from potentially faster economic growth. Right now, a big part of the world's economic growth is found in emerging-markets countries so emerging-markets funds may outperform other funds. For example, over the 12 months ending June 30, 2017, the MSCI Emerging Markets Index generated a total return of more than 23 percent, while international stocks in developed countries (represented by the MSCI EAFE Index, which stands for Europe, Australasia, and the Far East) returned about 20 percent, and large U.S. companies (represented by the S&P 500 index) returned almost 18 percent. Those are all outstanding positive returns with emerging markets leading the way, but that's not always the case. In 2015, for example, the large U.S. stocks gained just over 1 percent, international developed stocks lost about 1 percent, and emerging-markets stocks lost almost 15 percent.

What risks do I need to consider when investing in an emerging markets fund? Political risks tend to be higher in emerging markets than in developed countries. Governments in developing countries may have different rules about property ownership and there are risks that the government can expropriate property. There are also additional accounting risks. The U.S. and other developed countries have stable accounting rules to measure a company's income, but some emerging-markets countries do not. Emerging-markets currencies tend to be more volatile, which impacts the value of investments when converted back to U.S. dollars.

How should emerging-markets funds factor into my retirement savings? In addition to portfolio diversification, these investments may experience faster economic growth. But because of the additional risks and increased volatility, most financial professionals would caution against investing too much in emerging-markets funds. You may want to invest in a fund that includes some exposure to emerging markets and is managed by investment professionals who understand these risks. Many target-date and target-risk funds, for example, invest a small percentage of their portfolios in emerging-markets funds, with the percentage shrinking as your target date for beginning withdrawals gets closer and your risk tolerance decreases.

You can learn more about the workings of emerging-markets funds at this link.

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