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Emerging markets, which had a disappointing 2013, were a big theme of the Barron's Roundtable this year. While our participants may be divided as to the near-term prospects for the world's developing nations, everyone agrees that investors need to participate in the long term.
Based on the $39 billion that went into diversified (i.e., not country-specific) emerging-markets funds last year, investors seem to agree. But that enthusiasm created an unusual problem: Ten funds, including some of the category's largest and best-performing offerings, closed to new investors last year.
That's particularly problematic, given that the entire category has fewer than 200 funds (198, to be exact, according to Morningstar), and 83 of them don't even have a three-year track record. That severely limits the universe of experienced managers with proven records—and active management is arguably the best way to go when investing in emerging markets. Regular readers know that I'm often a proponent of indexing, and it's unlikely you'll go wrong over the long-term with an indexing strategy. If that's your preferred route, the broadest emerging-markets index ETF is the $38 billion iShares MSCI Emerging Markets (EEM), though its annual fee of 0.67% makes it pretty pricey for an index ETF.
A good manager can take advantage of the anomalies and inefficiencies rife in the emerging markets, navigating around China's economic slowdown, Brazil's troubled politics, and Russia's stagflation. Index investors get a disproportionately large helping of these countries; the MSCI index has 20% in China and 11% in Brazil. Plus, indexes tend to disproportionately favor each nation's largest companies, most of which are focused on natural resources and also tend to be partially state-owned. The MSCI index has half its portfolio in giant stocks such as Russia's Gazprom (OGZPY), Brazil's Petroleo Brasileiro (PBR), better known as Petrobras, and China's biggest producer of crude oil and natural gas, CNOOC (CEO). These companies are subject to price controls and other government influence that is geared toward economic policy and not corporate growth.
While picking a good emerging-markets fund might be a bit tougher these days, it's not impossible. Harding Loevner Emerging Markets (HLEMX) flies a bit under the radar, but this $2 billion fund packs quite a punch. It held up well last year, its 4.2% gain puts it in the top 20% of emerging-market funds, and it's handily beaten the MSCI index over five, 10, and 15 years. Its value discipline helps in downturns, but doesn't hinder in bull markets—the fund gained five percentage points more than the group norm of 18% in 2012, says Morningstar analyst Samuel Rocco.
Thornburg Developing World (THDAX) is a relatively new entrant, having been launched at the end of 2009, but it's had an impressive showing, thus far. The $2 billion fund has a big stake in consumer-oriented stocks; top holdings include Galaxy Entertainment (GXYEF), a resort and casino operator in Macau. The fund's go-anywhere approach means it can invest in companies of any size, in any country, which helped propel its 2013 16% return, which beat 96% of its peers.
An interesting alternative for investors who want to focus exclusively on the consumer: The EGShares Emerging Markets Consumer ETF (ECON) invests in 30 large consumer-driven companies, such as South Africa's multinational media company Naspers (NPSNY), Brazilian brewer AmBev (ABEV), and Russian convenience-store and grocery chain OJSC Magnit. Almost 40% of its assets are in Latin America, 35% are in Asia, and 20% in Africa and the Middle East.
China is, of course, the biggest powerhouse in the emerging markets. But making a specific bet on a troubled nation may not be the best idea. Regional funds provide a more targeted approach with less risk, particularly in the hands of the experts behind Matthews Asian Growth & Income (MACSX), a $4.3 billion fund that has almost 30% of its assets in emerging Asia. The fund uses convertible bonds and preferred stock to provide most of the income—it yields 2.42%—and to tone down the volatility of its more growth-oriented stock picks, such as hospitality company Genting Malaysia (GMALF).
Another good move, especially for investors more skeptical of the near-term prospect in emerging markets, is $23 billion American Funds New World (NEWFX). Though focused on emerging markets, the fund also invests in developed-market companies, so long as they get at least 20% of their revenue from business in the developing world. Right now, it has 59% of its assets in these multinationals, considerably higher than the 38% it's averaged in the past decade, according to Morningstar analyst Kathryn Spica. It can also invest up to 25% in emerging-market debt; its current stake is a more typical 11%, though that's considerable higher than the category's average of 3%. It has a 0.95% yield and returned 10% in 2013, beating 90% of peers. The fund is consistently at the top of its category.
Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.