Open-End Funds in Emerging Markets

The number of mutual funds on the market is staggering. At the end of 2012, the Investment Company Institute reported that 8,752 funds were on the market. Each fund has a different investment style, fee structure, and management team, and those factors influence how appropriate the fund is for you.

For example, if your interest is emerging markets in Asia, do you want a fund that also invests in Japan? Probably not, because Japan is a developed market, not an emerging one. Likewise, if you want to generate income from your investment, you'll probably be more interested in an emerging market bond fund than in a stock fund, because bonds are more likely to earn income than stocks are.

This article discusses open-end mutual funds, which are investments that collect money from many different people and invest it in different securities that fit the fund's stated investment objectives. The people who own shares in the fund can buy or sell them any day that the market is open.

The main offering document for a mutual fund is called the prospectus, and it tells you all you need to know. It explains the fund's investment objective, management style, performance history, and fee structure. You want to review this information before you invest in a mutual fund.

Your investment style

When you start looking at mutual funds, you'll see that they're categorized into narrow categories, and even then, you'll have a lot of funds to compare. But your interest in emerging markets makes your task simpler. Go to the lists of international funds. At some fund companies and with some research services, emerging market funds are separated from other funds that invest overseas. Other times, all international options are kept together, so you have to look at the fund name or the prospectus to find out how it invests.

Because the mutual fund industry has to find ways to categorize the thousands of funds, you find emerging market funds grouped in different ways. Here a few of the pros and cons of the different investment categories for emerging markets:

  • Diversified emerging market funds: These funds invest in any emerging market that strikes the fund manager's fancy, often allocating to countries in a similar proportion to the MSCI Emerging Markets Index. These funds have great diversification and give you wide exposure to the changing global economy, but you can't concentrate on any markets that you find to be especially attractive. These funds may be too broad to be managed well.

  • Regional emerging market funds: Is your interest in Africa? Latin America? Asia? Then you may want to consider a fund that invests only in one region. These funds have some diversification, and they let you concentrate on the regions where you see the most opportunities, but you may pick up some developed countries in the mix. In addition, problems in one country can bring down the performance of unrelated companies in unrelated countries that happen to be nearby.

  • Country-specific funds: These funds invest in only one country. These funds specialize in the markets you may care about, giving you exposure to the market without limiting your investment to just one company. However, they offer fewer diversification benefits, and fund managers may face difficulty finding enough good investments in some of the smaller countries to satisfy investor demand.

Research expertise

Mutual fund companies employ armies of analysts, traders, and portfolio managers who learn about the markets, tear through financial statements, and meet company management. They have the time and the expertise to navigate through the issues involved in emerging market investing.

Before you invest in a fund, find out about the manager's expertise in emerging markets and in other funds. Is the fund manager a specialist, or does she have responsibilities for completely different types of funds?

Emerging market expertise can be so specialized that many fund companies don't claim to have it. Instead, they hire sub-advisors — investment management companies based in or near the emerging markets, with great experience in those countries. The employees of the sub-advisory firm have the great knowledge and contacts that, hopefully, lead to better investment decisions with your money.

Fund family issues

Although each mutual fund is legally a separate company, with its own board of directors and officers, the reality is that mutual funds have next-to-no independence. Large corporations that are in the business of managing money organize almost all mutual funds. This structure may influence the funds that are available to you, especially if you're investing as part of an employer-sponsored retirement plan.

  • Dedicated international investors: Some mutual fund companies have a robust approach to global investing, with a team of analysts and portfolio managers who concentrate on markets outside of the United States. These firms often have offices in other countries and more than a dozen stock and bond funds in different developed and emerging market categories. These funds are more likely to have good options for emerging market investors than fund companies with less emphasis on international investing, although not always.

  • General fund companies offering emerging market funds: Because customers want international investments, some fund companies offer them even if these funds aren't really part of their core expertise. They may hire a fund manager with experience, or they may use a sub-advisor. Although you're less likely to find a great emerging market fund at one of these companies, you may, especially if the sub-advisor is a good one.

Fees

Mutual funds offer investors great convenience and professional management. Naturally, you have to pay for these services! In addition to the regular fees mutual funds charge, also be aware that emerging market funds tend to have higher fees than other types of funds because the research is more difficult. There just isn't as much information out there on the companies and countries. The fund managers probably travel to see what's happening for themselves, and that gets really expensive. Hence, emerging market funds are likely to have much higher expense ratios than funds that invest in developed countries. (Expense ratios include all of a fund's fees, not just its management fees.)

The higher expenses are worth it if you get the returns that you expect. That's why looking at a fund's performance is important.

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