International Indexes Miss Emerging Markets--And What You Can Do About It

A recent article in The Wall Street Journal,* “’Global’ Indexes Miss Emerging Markets,” warns that the major “global” equity indexes are primarily focused on the developed world, while emerging market exposure is underrepresented as a percentage of the total. According to the International Monetary Fund, emerging market output has increased about 50% over the last decade to about 30% of the global total. If measured by purchasing power parity, emerging markets account for about 45% of the global total.

The MSCI-EAFE Index has no emerging market presence (and is not meant to), while the MSCI All World Index has about 12% emerging market exposure (but is meant to).

Both the Lehman Brothers Global Aggregate Bond Index and JP Morgan Government Bond Index Plus have less than 7% emerging market exposure.

Of course there are specific emerging market indexes like the MSCI Emerging Markets index (tracked by Vanguard’s Emerging Market Index fund [VGEIX]). The warning is simply that an “international,” “world” or “global” designation is no guarantee that a non-U.S. equity or bond fund has an emerging market component.

An investor should check Morningstar to see how much emerging market exposure their “foreign” funds actually have. Emerging market stocks and bonds are superb diversifiers in reasonable amounts. Remember that emerging market stocks are among the volatile of all stock categories, and emerging market bonds are among the most volatile of all bond categories. But they can work to both enhance returns and reduce portfolio volatility if used in proper amounts relative to other major asset classes.

Below are two of the best choices in the dedicated emerging market stock class, one actively managed and one an index fund: T. Rowe Price Emerging Market Stock (PRMSX) and Vanguard Emerging Market Index (VEIEX).**

These are the abbreviations used below:

1-Year Return: 1Y
5-Year Total Annualized Return: 5TR
10-Year Total Annualized Return: 10TR
5-Year Tax-Adjusted Return: 5TAR
10-Year Tax-Adjusted Return: 10TAR
3-Year Standard Deviation: 3SD

Fund: 1YR/5TR/10TR/5TAR/10TAR/3SD

PRMSX: -13.85/23.30%/18.53%/23.19%/18.01%/23.57
VEIEX: -13.60%/21.89%/17.56%/22.81%/17.33%/21.84%

And here are two of the best choices in the emerging market bond class: Fidelity New Markets (FNMIX) and T. Rowe Price Emerging Market Bond (PRMEX).

Fund: 1YR/5TR/10TR/5TAR/10TAR/3SD

FNMIX: 5.88%/10.37%/16.115/7.51%/12.52%/5.16%
PRMEX: 5.04%/11/09%/15.29%/7.99%/11.51%/5.70%

By the way, notice the spread between the 1 year return figures of emerging stocks versus emerging market bonds. I averaged the 1 year returns of the two stock funds together and the 1 year returns of the two bond funds together and looked at the spread between the two. The stock funds averaged -13.72% versus 5.96% for the two bond funds. The spread is 19.62%. Whoa! If you have a good dedicated bond fund in your portfolio, good for you.

*From The Wall Street Journal, September 2, 2008, by Giada Cardoletti Litner.

**Vanguard’s Total International Stock Index (VGTSX) actually includes three funds within it: European Stock Index (VEURX-about 53%); Pacific Stock Index (VPACX-about 26%); and Emerging Market Stock Index (VEIEX-about 21%). So if this fund is 21% of a portfolio, the emerging market component would be about 4%.