ETF Investing Guide: Why You May Want Exposure to Emerging Markets

If you’ve made it this far, you have assembled a diverse portfolio of ETFs that track the major US asset classes (stocks, bonds, real estate) plus a developed market stock fund. Tax-loss selling and portfolio rebalancing allow you to manage the portfolio to maximize after tax returns and minimize risk. That’s enough for most investors. This chapter is for the more adventurous; it discusses how to extend your portfolio to cover emerging markets, and how to take advantage of discounted closed-end funds.

Emerging markets - countries like Argentina, Brazil, China, India, Indonesia, Korea and Singapore - make up a tiny proportion of the aggregate value of world stock markets. They therefore represent only a fraction of most global model portfolios. Furthermore, emerging countries’ stock markets are notoriously volatile, and most of them have under-performed developing countries’ stock markets over the last decade. So many investors will want to, and should want to, stick to the markets represented in the core ETF portfolio.

But there are three reasons you may want to consider adding a small exposure to emerging markets:

1. Economic growth. Some emerging market economies have grown considerably faster than the US and Europe over the last five years, and are expected to continue to do so for the next five years. As a technology analyst, I’m particularly interested in China and India. China combines low cost manufacturing with an immense domestic market and an impressive annual supply of graduates. China’s economy has become more free-market-oriented, and the country has joined the World Trade Organization. (Hopefully political and human rights will also catch up.) China could become the dominant manufacturing source for everything from apparel to technology over the next five years. India, meanwhile, has a massive pool of educated, low-cost, English-speaking workers, and an excellent educational infrastructure. India is fast becoming the provider of outsourced services for the English-speaking developed countries. Many investors will want exposure to these economies.
2. Valuation. This reason to add some portfolio exposure to emerging markets is exactly related to their under-performance over the last decade. Compared to many developed markets, emerging markets stocks are cheap. Financial transparency and reporting have improved in many emerging countries, while the US and Europe have been plagued by their own accounting scandals. Together, these developments to some degree undermine the justification for emerging market stocks to trade at a discount to developed market stocks.
3. Diversification. Adding a small position in emerging market stocks further increases the diversification of your portfolio. And in today’s uncertain world, geographical diversification seems a good thing.

So we’ll now discuss how you may add exposure to emerging markets in an interesting, and potentially profitable way.

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