Opinion: Should we stick to emerging markets? Advisors intervene

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Ouch.

If you have an “emerging markets” equity fund in your IRA or 401 (k), you’ve been uncomfortable for a few days.

Emerging markets collapsed after the Chinese Communist government clamped down on some of the country’s tech giants. Chinese stocks dominate emerging market indices these days, accounting for around 40% of the typical fund.

Widely held funds such as the Vanguard Emerging Markets Stock Fund VEMAX,
-0.75%
and its VWO ETF equivalent,
-0.68%,
iShares Core MSCI Emerging Markets IEMG,
-0.81%
and iShares MSCI Emerging Markets EEM,
-0.84%
lost 5% of their value in a matter of days, although they have since rallied.

This left them down around 5% since the start of the quarter on July 1 (the New World fund actively managed by American Funds NEWFX,
-0.52%
held up better and is down 2.5%)

More importantly for long-term investors, this comes after a pretty bleak decade for emerging markets. Even taking into account reinvested dividends, the typical EM equity fund has accumulated a total return of 35% over the past 10 years.

During the same period, an investor in the US S&P 500 SPX Stock Index,
+ 0.17%,
for example via the SPDR S&P 500 Trust SPY,
+ 0.17%,
won over 300%.

With that in mind, does the typical saver even need or want an emerging markets fund in their 401 (k) or IRA?

Ian Weinberg, financial planner at Family Wealth & Pension in Woodbury, NY, argues against. Emerging markets, and even developed international markets like Europe and Japan, offer you more risk and less return, he says. “Foreign stocks have a strong correlation with US stocks when the US markets fall, and then have a lower correlation with US markets when they rise,” he tells me. “It just means that foreign stocks have started to offer poor risk and reward characteristics. Would you invest in something that goes down as much or more than national stocks and increases less than national stocks when they are running? “

Foreign stocks today seem cheap relative to the United States for a reason, he says: “Europe cannot get out of the current negative interest environment, and emerging markets, dominated by China. , are subject to government intervention and a risk of stability. Meanwhile, American companies all have a lot of overseas exposure anyway, he points out. You can get full exposure to international growth opportunities with the S&P 500.

He is not alone. BRK.A from Berkshire Hathaway,
+ 2.10%

BRK.B,
+ 1.93%
President and investment genius Warren Buffett says most people are probably better off holding 90% of their portfolio in a US stock index fund and 10% in US Treasuries.

But it takes two perspectives to make a deal, and many advisers take the other side of the argument.

“Emerging markets should definitely be a part of everyone’s long-term allocation,” says financial planner Ken Nutall in West Grove, Pa. Emerging markets tend to “zig” when other markets “zag,” he says. Emerging markets also offer many opportunities for growth. “They tend to be volatile, but over longer periods of time they tend to outperform,” he says.

“Ordinary investors should definitely have a weighting towards emerging markets in their long-term investment strategy,” agrees Jay Karamourtopoulos, financial planner in Boston. “As global economies are now more connected than ever, there are still diversification benefits to investing in emerging markets,” he says. He adds: “Most investors have a penchant for the home country to begin with. Add to that the strong US returns over the past decade and it can be argued that many individual investors were seriously overweighting domestic stocks. “

“Yes, of course people should be invested in emerging markets,” agrees planner Chris Chen in Lincoln, Massachusetts. “It’s part of diversification. China, he says, is the world’s second-largest economy and will soon be the largest. “How do you ignore them? “

And many advisers say one of the reasons to take a closer look at foreign markets, including emerging markets and developed markets such as Europe, is precisely because they’ve done so poorly for a decade. Emerging market stocks have underperformed US stocks over the past decade, according to planner Robert Cheney in Palo Alto, Calif. But it does mean that “emerging markets are [now] cheaper in relative terms… and there could be a mean reversion over the next decade.

“Emerging markets in general have had a tough time over the past 10 years,” says Miami planner Brian Fischer. “However,” he adds, “there have been individual years recently and other periods historically where they have done relatively much better. There is a diversification benefit, this is just when that benefit is incredibly difficult.

Those who avoid emerging markets because they have done poorly lately, adds adviser Jordan Benold of Frisco, Texas, might keep in mind “the fundamental philosophy of buying low and selling high.”

For my part, I have been covering financial experts for over two decades and these things seem to have happened in cycles. I remember in 2010, when emerging markets were in the lead, the mainstream was cheering them aggressively. If the cycle were to turn again, I wouldn’t be surprised.

A big challenge today is that China dominates emerging markets so completely that your typical emerging market fund is not really diversified. Add to that the problem that China is a rigged market controlled by the Communist Party (and the risks China can pose to Taiwan, by the way). Planner Chris Chen sees the value in separating Chinese and non-Chinese emerging markets as separate allocations. It makes a lot of sense.

Franklin Templeton offers a Chinese FLCH ETF,
-1.17%
with a moderate annual load of 0.19%. BlackRock’s iShares offers an emerging markets fund that excludes China, iShares MSCI Emerging Markets ex China ETF EMXC,
-0.71%,
charge 0.25% per year. Its main countries are 22% Taiwan, 21% South Korea, 16% India and 9% Brazil.

Joachim Klement, strategist at Liberum and leading researcher at the CFA Institute, says the most truly diversified equity portfolio is one that tracks, not the US or any other country or region, but the MSCI All Index -Country World ACWI,
-0.16%,
which includes the United States, Europe, Japan, Australasia, emerging markets and everywhere else. This is also the strategy of some low-cost exchange-traded funds such as the Vanguard Total World Stock ETF VT,
-0.09%
and SPDR Portfolio MSCI Global Stock Market ETF SPGM,
-0.28%.

Note that they still hold nearly 60% of their money in US stocks (which is roughly three times the US share of global economic output, according to the IMF) due to US valuations. Emerging markets represent a modest 11% of the fund. Do whatever you want with it.


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