Emerging markets might be out of favor at the moment, but that hasn't stopped the asset-management industry from positioning products and strategies for an eventual turnaround.
As detailed in a recent Morningstar report, emerging-market strategies have come a long way from the days of broad-market indexed exposure to the couple of dozen countries classified as emerging economies.
Of the 304 mutual funds and exchange-traded funds focused on the emerging markets, 74 funds, or nearly 25%, are dedicated to specific segments and strategies within the broader emerging markets.
Morningstar analysts Bill Rocco and Gregg Wolper segmented the divergent funds into four unofficial subcategories, including geographically flexible, small-cap, multi-asset, and frontier markets.
“The group of funds has gotten bigger and much more complex, and we're trying to help people to better understand the strategies,” said Mr. Rocco.
From Morningstar's perspective, the subcategory that could be most useful to investors and financial advisers, as supplementary emerging-markets exposure, is the 24 funds comprising the geographically flexible group.
Source: Morningstar, Inc
Note: Data as of 10/31/2015. Number of open-end funds and ETFs as of these dates, excluding offerings that
have since been liquidated or merged away
These funds generally include greater exposure to developed-market companies that generate significant revenues in the emerging markets.
FINDING VALUE
For example, the most recent data from American Funds New World (NEWFX) showed that its equity exposure was split evenly between companies based in emerging markets and companies headquartered in developed markets.
“With the geographically flexible funds it can be a less volatile way for investors to invest in the emerging markets,” Mr. Rocco said. “The funds in that subgroup have a lot of use and I think that's why they exist, but investors can get as creative as they wish.”
While the Morningstar report
identifies the funds represented in each subcategory, it also presents a general theme that too much fine-tuning in the emerging-markets space can become costly and ineffective, and lead to over-diversification.
But even if most investors are allocating less than 10% of their portfolios to emerging markets, the asset-management industry believes there is
value in looking beyond the traditional allocations.
“Our solution to the emerging markets story is actually all of the above, and we think we're offering a one-stop solution,” said Gerardo Rodriguez, co-manager of the BlackRock Emerging Markets Allocation Fund (BEEAX).
BLACKROCK
As one of nine funds making up the multi-asset subcategory, the BlackRock fund invests in both stocks and bonds, but this fund will also take short positions.
“Diversification in the emerging markets has become much more important that it was before,” said Mr. Rodriguez. “In order to capture the essence of the emerging markets of the future, you can no longer just look at one factor; you need to also look at other sources that can explain returns in the emerging markets space.”
The fund, which has a 61% weighting in bonds, is down 5.6% so far this year, which compares to a 7.78% drop by the MSCI ACWI emerging markets index.
Multi-asset is both the smallest and the newest of the emerging-market subcategories. Five years ago there were no funds fitting the definition.
Sam Polyak, co-manager of the Fidelity Advisor Total Emerging Markets Fund (FTEDX), said the unofficial subcategories are just the beginning of where the asset-management industry could go with regard to the emerging markets.
“Back in the 1990s all you had was core emerging market funds, but eventually I think emerging market funds will start to look more like funds investing in [developed] Europe and the U.S.,” he said.
Mr. Polyak said the benefit of investing in both debt and equity inside a single fund is that there is limited geographic overlap. For instance, 70% of the emerging-market investable equities are in Asia, while 70% of the investable debt is from Latin America and Europe.
The Fidelity fund, which has about 40% in bonds, is down 6.18% so far this year.
Dissecting and dividing the overall emerging-markets category makes sense to Todd Rosenbluth, director of mutual-fund and ETF research at S&P Capital IQ.
“The emerging markets tend to get painted with a very broad brush,” he said. “Even though these are still emerging markets, the capital markets have grown up.”
Among financial advisers, the more specific strategies can sometimes be slow to catch on.
“I'm steering away from the frontier markets because I think the funds are too expensive and there hasn't been enough research done in those markets yet,” said Rose Swanger, principal at Advise Finance.
“I'm still with the broad emerging markets exposure where there are lots of analysts and I trust their research,” she added. “The rarer the strategy, the harder is gets to do the research.”
James Bryan, principal of wealth management at Cahill Financial Advisors, is among those advisers that have begun dabbling beyond the broad market bread-and-butter indexes.
“We're investing in broad market exposure, but we're also committed to the frontier arena,” he said.
Regarding the recent
poor performance of the emerging markets, in general, Mr. Bryan said he is sticking to his plan.
“If you're going to reset you're thinking, you don't do it when you're headed, near, or at the bottom,” he said. “Our staff has done the research, and our clients are aware of the risks.”
