(PUB) Investing 2016

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The Wild World of Emerging Markets Morningstar Research | Bill Rocco and Gregg Wolper

amount of developed-markets stocks. Rather, the managers include a few developed-markets companies in their portfolios because they meet their investment criteria, and the emerging-markets component of these firms’ business is sizable. These funds have different percentages of assets in developed markets, and their styles and strategies distinguish them in other ways, too. In other words, having some assets in developed-markets-based companies isn’t a complete strategy, just an aspect of a fund’s approach. Beyond the Big Names For decades, investors who wanted to focus on small or midsize companies in the U.S. have had plenty of fund options from which to choose. Fund compa- nies took their time venturing into the emerging- markets arena, however. Nearly all of the more than two dozen emerging-markets funds that focus on small- and mid-cap stocks arrived on the scene after 2005 . (We define this subgroup as normally having average market capitalizations of $3 billion or below.) Some have most of their portfolios in micro-, small-, and mid-cap stocks, while others are quite willing to include many large companies in their mix. Besides the size distinctions, the funds also take different strategic approaches. Not surprisingly, small/mid-cap emerging-markets funds not only perform much differently from conventional diversified emerging-markets funds and indexes but also from each other. In general, they typically notch even greater gains than large-cap emerging- markets stocks during rallies, and they often fall further during downturns. Unlike geographically flex- ible funds, therefore, these funds do not hold out the prospect of damping volatility in a notoriously volatile area—just the opposite. Taking the Multiasset Approach Another variety of emerging-markets fund that has appeared in recent years is the balanced or multiasset portfolio. Instead of investing all or nearly all of their assets in stocks, these funds also allocate assets to emerging-markets bonds, and some add an extra twist by making currency plays or other investments.

Twenty years ago, only about two dozen mutual funds focused on emerging-markets stocks. (There were no emerging-markets exchange-traded funds.) Almost exclusively, they targeted prominent firms located in emerging markets. Now, investors can choose from more than 300 mutual funds and ETF s—and they’re an increasingly diverse lot. Beyond the traditional variety, four other types are available as well: p Geographically flexible funds, which invest signifi- cant chunks of their assets in companies that have extensive business in emerging markets but are head- quartered in the United States, Europe, or other developed markets. p Multiasset funds, which divide their assets between emerging-markets stocks and emerging-markets bonds (and in some cases currencies and more). p Frontier-markets funds, which target countries that rank below emerging markets in terms of stock market access and other factors. Geographically Flexible Funds Approximately two dozen funds now take a geographi- cally flexible approach to emerging-markets investing. These funds are far from identical. American Funds New World NEWFX invests half its stock portfolio outside of emerging markets and also owns some bonds. Very few of the others invest that much in developed markets, and most don’t own bonds. Still, a good number of geographically flexible diversified emerging-markets funds regularly invest 15% or more of their stock portfolios in developed-markets compa- nies with ample business in emerging markets. Many such funds do not intentionally go out of their way to ensure their portfolios consistently have a certain p Small/mid-cap funds, which focus on companies beyond the big, widely owned names.