[Article updated by David Dierking on September 12, 2017]
With a stock market that is on pace to post its ninth consecutive year of gains and, by some measures, looks a little expensive, it’s a good time to reconsider the potential of international mutual funds. They tend to come with a higher degree of risk, but also provide added growth potential and can help reduce overall portfolio volatility.
Investing in emerging markets requires a higher risk tolerance but it also provides some of the best opportunities for growth. ETFs have popped up offering exposure to just about any individual country you can think of. In the highly specialized area of emerging markets investing, it often pays to have a manager at the helm who is familiar with the ins and outs of investing in these areas. In this case, an emerging markets mutual fund may make more sense than a passively managed ETF, despite a potentially higher cost.
In case if you are wondering whether mutual funds are right for you at all, you should read why mutual funds, in general, should be a part of your portfolio.
Emerging Markets to Explore
While investing overseas can help boost portfolio returns, that certainly hasn’t been the case over the past decade. In the ten-year period from 2006 through 2016, the MSCI Emerging Markets index lost 5%. Many of these less developed economies were plagued by a lack of growth and governments that were crippled by debt and political unrest. With volatility high and the performance of individual countries varying widely, investors needed to target specific regions of the world in order to turn a profit.
2017 has been a different story. Emerging markets have been rallying strongly across the board. Even countries with major political problems, such as Brazil, which has been mired in scandal as its top government officials have been accused of bribery and corruption, are posting solid gains. With the exception of Russia, every single-country ETF has posted gains on the year, with many returning over 20%. Fueled by stronger growth prospects and attractive valuations, investors have poured billions of dollars into emerging markets funds, making them some of the marketplace’s hottest investments.
The New Emerging Markets Paradigm
Many emerging markets funds are dominated by Asian countries, with Latin America and Europe fighting for a distant second. China is becoming a major economic player on the world stage and has been growing its economy rapidly for much of the past decade. Much of that growth, however, is fueled by government spending, and increasing debt levels could ultimately slow down the economy. Government devaluation of the yuan further exacerbates the risk coming from this region.
India is another country on the emerging market’s radar. This country has two things going for it right now: income growth and population growth. Increasing consumer spending along with a growing presence in the tech industry should continue to make India one of the fastest-growing economies in the world. You can check our India section to explore more funds focused on India.
On the flip side, Russia has been perhaps the biggest drag on the world economy. Russia is heavily involved in the oil industry, a space that has struggled with low energy prices for much of the past three years. High inflation rates and tougher economic sanctions imposed by the United States have further contributed to the nation’s struggles.
Navigating the Emerging Markets Mutual Fund Space
Investors are probably best off sticking with broadly diversified emerging markets funds. Since investing in these regions of the world carries additional cost due to lack of liquidity and accessibility, it’s also important to target funds that limit expenses. Some top-rated emerging markets equity funds that have low expense ratios are American Funds New World (NEWFX), the RBC Emerging Markets Equity Fund (REEIX) and the Fidelity Emerging Markets Fund (FKEMX).
Emerging markets bond funds provide a similar enhanced return potential for fixed-income investors. The T. Rowe Price Emerging Markets Bond Fund (PREMX) is a popular fund in this space that has historically delivered above-average returns with below-average risk.
The Bottom Line
Emerging markets funds usually deserve a modest allocation in most portfolios. Despite the fact that strong returns in 2017 have drawn in a lot of investors that might not have considered this segment in the past, it’s important to remember that these are developing economies that are not stable and come with a high degree of risk. They can deliver excellent returns when the winds are at their back, but can also turn south quickly when things look uncertain.
Be sure check our News section to keep track of the recent fund performances.