What it means
Investors put their money into the fund, and the fund manager invests it across a range of securities in countries such as India, Brazil, South Africa or Indonesia. Each investor owns units or shares in the fund and receives a share of any gains, income and losses.
Funds can focus on shares, bonds or a combination of the two. Many emerging market funds are actively managed, meaning that a manager and research team select what they believe are the best opportunities.
Others follow an index passively. Active funds typically charge higher fees, and the question for investors is whether the manager's skill adds enough extra return to pay for them.
The case for these funds rests on growth. Economies with faster expansion, young populations and rising incomes may produce companies with higher earnings growth than those in mature markets.
The fund spreads the risk across many companies so that no single failure can do major damage. The risks are significant.
Local currencies can fall against the dollar, reducing returns for foreign investors, and political events or policy changes can hit markets suddenly. Liquidity (how easily an asset can be sold without moving its price) can also be lower, making it harder to exit during a crisis.
Investors typically use these funds as a smaller part of a diversified portfolio, often between 5% and 15%. Regular reviews are wise, because the proportion can drift higher after a strong year.
Reading the fund's prospectus shows its goals, fees, risks and holdings. Funds differ in how they treat risk.
Some hedge part of their currency exposure, while others leave it fully open, and some limit how much can be placed in any one country. These design choices affect both the ups and downs, so they deserve as much attention as the fund's headline return.
In practice
Real-world examples.
Example
A pension plan adds an emerging market fund to its equity portfolio to improve diversification. The trustees set a limit of 10% of the plan's equities and review it each year. Their annual review checks that the fund has not drifted above the limit.
Example
A young professional invests in an actively managed emerging market fund through a workplace savings plan. She chooses it for long-term growth and accepts the possibility of big short-term swings. She reviews the statements twice a year, and rebalances if the fund has grown too large.
Example
A wealth manager compares two funds, one focused on shares and one on local-currency bonds. The bond fund pays steady income but is exposed to currency movements, while the share fund offers more growth potential with greater volatility. The manager explains the trade-off to the client in plain language before recommending either one.
Formula
Calculation
Contribution to portfolio return = allocation weight x fund return.
Worked example: an investor has a $200,000 portfolio and allocates 10% to an emerging market fund, which returns 15% in a year.
1. Amount invested in the fund = $200,000 x 10% = $20,000
2. Gain on the fund = $20,000 x 15% = $3,000
3. Contribution to the whole portfolio = 10% x 15% = 1.5%, which is $3,000 / $200,000
If the fund instead lost 20%, the loss would be $20,000 x 20% = $4,000, which reduces the whole portfolio by 2%. This shows why a modest allocation limits damage as well as gain.Case study
Seen in the real world.
Horizon Family Office is an illustrative, fictional firm advising a family with $10,000,000 invested only in domestic shares and bonds. The family wanted higher long-term growth and agreed to look at emerging markets.
The advisers proposed an allocation of 8%, or $800,000, split between an active fund and a low-cost index fund. They wrote down the reasons for the investment, the maximum loss the family could tolerate and a rule to rebalance once a year.
In the third year, the emerging market holdings fell by 25%, a loss of $200,000. Because the allocation was small and agreed in advance, the family held steady and the investment later recovered. The illustrative lesson is that position size and a written plan matter as much as picking the right fund. The advisers also reviewed the fund fees every year and moved some money to a cheaper share class once the holding had grown large enough to qualify.
Watch out
Common mistakes.
- Putting too large a share of savings into a single emerging market fund.
- Choosing a fund purely because of last year's strong return.
- Overlooking fees, which can be considerably higher than in developed market funds.
Questions
People also ask.
What does an emerging market fund invest in?
It invests in shares, bonds or both from countries with developing economies, such as parts of Asia, Latin America, Eastern Europe and Africa.
What is a sensible allocation?
Many advisers suggest a modest slice of a diversified portfolio, but the right figure depends on your goals and tolerance for risk.
Should I choose active or passive?
Passive funds cost less and track an index, while active funds try to beat it at a higher fee, so compare long-term results after fees.
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