While the market rally that began just over a year ago has boosted stocks across the board, some areas have rocketed to the head of the pack. One of the biggest beneficiaries of the market recovery has been emerging markets, with the MSCI Emerging Markets Index having roughly doubled since March of last year. But if you're looking to invest in this volatile sector of the market, you'll need to proceed with caution.
Investors have certainly noticed emerging markets' red-hot returns. As is usually the case, folks have started chasing the big returns this sector has posted in the past year, shifting billions of dollars into the asset class. And while investors of all stripes should make room for emerging-market names in their portfolios, now is not the time to load up heavily on this sector just because it has done well recently. Chasing performance is a losing investment strategy, and the fact that these markets have done so well recently actually makes the possibility of a pullback more likely.
While I still believe that some of the greatest growth prospects of the next decade will be found in developing countries, the near-term outlook may be a little bit bumpier. China's real estate market has begun to show signs of a bubble, alongside recent inflation numbers that seem to indicate a danger of overheating. The government has taken some small initial steps to rein in lending to cool down the economy. Likewise, the Brazilian and Indian stock markets have seen massive run-ups in the past year and have been flooded with investor dollars. And of course, there's the fiscal trouble brewing over in Greece, not to mention the fact that Portugal's debt has just been downgraded by credit-rating agency Fitch. If nothing else, there certainly is a lot of risk swirling around in emerging markets right now. And that risk has implications for how you should invest.
Seeing the big picture
Investors are frequently lured by the outsized gains that emerging markets can generate, but many times they forget that they can also be just as prolific on the downside. For example, during the financial crisis, emerging markets plunged by a cumulative 60%, far more than developed markets, including the United States. Higher returns don't come without higher risk, a fact that investors all too often forget when they're pursuing fat returns. So if you're investing in emerging markets, you need to take a long-term outlook and be willing to sit tight through some pretty wide swings.
Given the current state of the global economy and the level of risk inherent in emerging markets, one of the safest ways to invest in this area is through mutual funds or ETFs. Especially now, you don't want concentrated exposure to one single emerging country, region, or foreign sector. Diversification should be your primary tool in managing risk in this arena. That means investing across multiple countries in an attempt to limit country-specific blowups.
A few good funds
If there's one corner of the market that most investors could use some professional help in, it's emerging markets. Because developing countries often have murkier accounting laws or less stable economic or political environments, it can be trickier to figure out which companies are good bargains. That's why it helps to get advice from a team with a history of investing in this area. One good actively managed fund to consider is Acadian Emerging Markets (AEMGX). This fund currently invests in some of the big-name emerging-market plays such as Petroleo Brasileiro
If you're not a fan of active management but still want a take a broad-based approach to emerging-market investing, consider Vanguard Emerging Markets Stock Index (VEIEX). For a mere 0.40%, you'll get an allocation to big-name emerging stocks such as Teva Pharmaceutical
There is undoubtedly a lot of risk and a lot of opportunity in emerging markets today. While long-term gains are likely, investors should moderate their expectations for continued high-powered returns in the immediate future. But with the right fund investments and a patient outlook, you can profit from the incredible growth potential of emerging markets.
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Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she didn't own any of the funds or companies mentioned herein. America Movil A.B. de V. is a Motley Fool Global Gains selection. Petroleo Brasileiro is a Motley Fool Income Investor selection. The Fool owns shares of China Mobile and has a disclosure policy.