McCall’s Call: Emerging Markets Come Of Age

June 24, 2010

Emerging markets have gone from the bastion of the boldest to an important piece of every portfolio and, like it often is in the world of ETFs, there are plenty of funds to choose from.

Investing in emerging markets, which 10 years ago only the bravest would consider, is now nearly all the rage. Indeed, it’s tough to argue against investing in countries such as Brazil, Russia, India and
China
when you take measure of their returns over the past decade.

Matthew D. McCallThe average annual return of the MSCI Emerging Markets Index in the past decade is 8.2 percent, versus an average annual loss of 3.0 percent for the MSCI USA Index. Over the entire 10-year period, that emerging markets index has more than doubled in value, increasing 120 percent, while an investment focused solely in U.S. companies would have lost more than a quarter of its value.

Most investors have difficulty picking individual stocks in developed markets and even more trouble in emerging markets. That’s why ETFs loom so largely as the best and least expensive option for most investors looking to take advantage of the high-growth potential of the emerging market countries.

The devil’s in the details of course, both in terms of deciding how big your allocation to emerging markets should be, and the most appropriate emerging market ETF to own. That’s because the emerging markets, for all their stellar performance, remain relatively volatile, and different ETFs have different returns and costs.

While it all depends on your appetite for risk, I’d say that if you’re in your 20s, you could go as high as a 25 percent allocation to the emerging markets. That percentage drops significantly as you age, meaning that if you’re a baby boomer, you really shouldn’t go above 10 percent. Again, knowing your risk appetite is always important in investing—and all the more so when it comes to emerging markets.

The Majors

The biggest of the broad-based funds that most individual investors seek is the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM). The ETF is composed of over 630 stocks from emerging market countries, including China (19 percent) Brazil (15 percent) and
South Korea
(13 percent). Its largest holding, the Korean electronics company Samsung, only makes up 3 percent of the portfolio.

The one issue I have with EEM is the expense ratio of 0.72 percent. For less than half that amount, investors can opt to buy the Vanguard Emerging Markets ETF (NYSEArca: VWO) with an expense ratio of 0.27 percent.

The Vanguard ETF has over 830 stocks in its allocation and $23 billion in assets versus $32 billion for EEM. That is big money in the world of ETFs, enough to make them the fifth-biggest and third-biggest of all
U.S.
, respectively. ETFs at the end of May, according to data compiled by IndexUniverse.com. The three- and five-year annualized returns are nearly identical for the two funds, so the edge must go to VWO based on fees.

 

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