CONNECTICUT MONEY: Understanding emerging markets

Emerging market funds delivered banner returns to investors last year, with Morgan Stanley’s MSCI Emerging Markets Index reflecting a 37.3 percent surge in 2017. Analysts do not expect the sector to deliver such stellar results this year, but that doesn’t mean it’s an area you can ignore.

Investing in emerging market economies may help with portfolio diversification, so it’s a part of investment planning that is important to understand. An emerging market fund is a fund that invests most of its assets in securities from countries with so-called emerging economies, meaning they are experiencing economic growth but are not yet fully developed economies.

Emerging market securities can offer higher potential returns at the cost of a higher risk profile, and they include stocks and other asset classes. Last year marked the first year of returns above 20 percent for the sector in a decade, since a 78.5 percent average return in 2009, according to the MSCI index. In the intervening years, returns were up and down, at 18.9 percent in 2010, minus 18.4 percent in 2011, 18.2 percent in 2012, minus 2.6 percent in 2013, 2.2 percent in 2014, minus 14.9 percent in 2015, and 11.2 percent in 2016.

Emerging market funds differ from international (or “foreign”) funds. International funds sold in U.S. markets tend to invest in securities of countries outside of the U.S. In addition, International funds typically invest the majority of assets in developed countries vs. emerging countries.

Each type of fund offers a different risk outlook. Financial planners often advise people to place some portion of their money into these types of funds to diversify their portfolio away from an over-reliance on U.S. securities, and to add some potential for higher returns while taking into account the greater risks.

Dozens of countries are classified as “emerging market” economies at any given time, and different funds and indexes include different countries. The best-known are the so-called “BRIC” economies, Brazil, Russia, India and China. Other countries frequently included are Argentina, Mexico, Turkey, Nigeria, Chile, Czech Republic, Egypt, Greece, Hungary, Indonesia, Israel, Malaysia, Pakistan, Peru, Romania, Ukraine, South Korea, Taiwan, Thailand, Oman and the United Arab Emirates, among others.

The positives among these countries are rising consumer clout, growing industrial production rates, and young and large labor pools. The negatives, which account for much of the risk involved, include smaller consumer bases, currency risk, geopolitical risk, lower trading volumes, higher volatility rates, and companies with less potential oversight from regulators.

As investors, having different styles of investments and geographic diversification can be helpful with your long-term financial planning. Take the time to understand these investments and how they may fit into your current investment portfolio.