For many investors, there no longer is a question of whether to invest some money in funds that focus on the world’s emerging markets—the question is which funds.

Since the first emerging-market fund was introduced to US investors 25 years ago, hundreds have been launched covering a wide range of approaches. There are funds for the most aggressive investors and for more cautious ones…some that specialize in bonds rather than stocks…funds that concentrate on particular parts of the world…and even funds that invest in single countries.

Many emerging-market nations have healthier balance sheets and better outlooks for fast economic growth than developed nations, especially when much of Europe is struggling with recession and the US economy is only creeping upward. Emerging-market companies offer opportunities for attractive returns, in part because some benefit not just from exports to developed nations but also from booming local and regional economies.

Emerging markets have rewarded patient long-term investors with 15% annualized returns over the past decade, more than double the gains of the Standard & Poor’s 500 stock index.

Bottom Line/Personal asked international fund specialist Todd Rosenbluth to describe the outlook for emerging markets and sort out which funds are best for various types of investors…

WHAT TO EXPECT

Research at my firm points to a moderately good performance in 2013 for emerging-market stock funds—which averaged overall gains of 12.4% in 2012 (through November 30)—and significantly higher returns in the long run.

That forecast is based, in part, on my belief that there won’t be the kind of financial meltdown in the eurozone that could trigger a global recession…and that China, the world’s second-largest economy, will produce economic growth around 8%. That’s less than the 10%-plus annual growth it had become used to but still strong enough to help lift other Asian countries. Overall, emerging-market economies will likely grow by 5.7% next year, compared with the 2% or so growth likely in the US.

Of course, there are near-term risks that investors need to be aware of. Volatility will remain very high…and some big emerging markets such as India continue to suffer from persistent inflation and a business environment plagued by corruption and government red tape.

Given the risks and opportunities, a typical investor’s portfolio of 60% stocks and 40% bonds should have about 5% of the overall assets in emerging markets. This can improve your overall returns in the next decade without raising your risk level too much.

BEST FUNDS

A fund that provides a simple low-cost way to get exposure to a wide range of stocks in emerging markets: Vanguard MSCI Emerging Markets ETF (VWO). With nearly 900 stocks spread across 21 countries, this fund is a good core holding, with an annual expense ratio of just 0.2%. Top stocks include telecommunication giants China Mobile and América Móvil based in Mexico, as well as the Russian oil-and-gas company Gazprom. Performance: 3.7%.* www.Vanguard.com

A fund that provides substantial income as well as growth from emerging-market stocks: WisdomTree Emerging Markets Equity Income Fund (DEM). In addition to income, dividends can provide proof of a foreign company’s strong cash flow and management’s commitment to shareholders. This fund owns shares in about 250 of the highest-dividend-yielding stocks in 17 emerging markets, with heavy emphasis on Brazil, China and Russia. Top holdings include China Construction Bank Corp. and the Brazilian mining company Vale. Recent yield: 3.6%. Performance: 7.5%. www.WisdomTree.com

A fund that has lower risk than most emerging-market funds but still produces good returns: Laudus Mondrian Emerging Markets Fund (LEMIX) looks for big undervalued companies with strong balance sheets. It keeps one-quarter of its assets in financial-services firms that dominate their local markets. The fund has done much better than its peers in avoiding big drops in down markets, and its five-year performance puts the fund in the top 9% of its category. Performance: 5.3%. www.LaudusFunds.com

A fund that takes bigger risks—and reaps bigger rewards: Oppenheimer Developing Markets Fund (ODVYX) practices a theme-based approach—for instance, investing in large retailers in developing nations to take advantage of the spending habits of the growing middle classes. Top holdings among the fund’s more than 100 stocks include FEMSA, which operates Mexico’s largest convenience store chain, and SM Prime Holdings, the largest shopping mall and retail operator in the Philippines. Performance: 8.3%. www.OppenheimerFunds.com

A very aggressive fund that focuses on some of the fastest-growing countries in the world: Matthews Asia Growth Fund (MPACX). Asia will be a sweet spot in the next few years. Countries such as Indonesia, the Philippines, Thailand and Vietnam all are experiencing annual economic growth rates of 5% to 6%. China’s new generation of leaders will take their posts in early 2013 and start instituting policies that will encourage stronger domestic growth. But betting on a single Asian country is too risky for most investors. This fund spreads its bets among about a dozen Asian countries, focusing on companies with sustainable growth selling at reasonable prices. These include Sinopharm Group, China’s largest health-care products distributor, and NagaCorp, a Cambodian gambling and hotel operator. The fund also lowers volatility by investing in developed nations in the region that profit from Asia’s growth, such as Australia. Performance: 8.4%. www.MatthewsAsia.com

A fund that provides high yields: Fidelity New Markets Income Fund (FNMIX). This fund keeps about two-thirds of its assets in emerging-market government bonds (denominated in US dollars to avoid making bets on foreign exchange rates) and one-third in emerging-market investment-grade corporate bonds. This mix has produced a recent yield of 4.6% versus 1.6% for a comparable portfolio of US bonds. Fidelity has proved adept at identifying undervalued bonds in smaller developing markets such as Croatia, Poland and Venezuela. This fund is best for aggressive, long-term bond investors because it can be more volatile than comparable US bond funds. Performance: 12.5%. www.Fidelity.com

*All performance figures are based on three-year annualized returns through November 30, 2012.

Related Articles