(PUB) Investing 2016

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9 Morningstar FundInvestor April 2016
The aim is similar to that of the geographically flexible
funds: to give investors access to the potentially
greater gains available from emerging markets while
reducing the volatility inherent in an all-
stock approach.
The theory had numbers behind it. In the years just
before many of these funds came out—five of the
current crop of 12 launched in 2011, with the rest in
the years since—the short-term losses of emerging-
markets bonds had regularly been much more
moderate than those of emerging-markets stocks.
Conversely, when emerging-markets stocks roared
ahead, the bond gains had been more modest.
Given how young these funds are and the tough
environment they’ve had to deal with, it’s too soon to
provide a definitive evaluation of their performance.
Broadly speaking, though, the inclusion of bonds does
seem to have moderated the performance swings
of the funds.
Venturing Outside the Boundary
Yet another type of nontraditional option reaches
beyond the commonly defined emerging-markets
universe. In MSCI ’s view, frontier markets are a
separate group of countries that rank even lower
than emerging markets in terms of stock market
size, liquidity, and openness to foreign shareholders,
among other factors. There are now 15 frontier-
markets funds, including mutual funds and ETFs (not
including portfolios that focus on a single frontier
market or region). Some restrict themselves to those
countries defined as frontier markets by an index
provider. Others also invest in some smaller countries
that are classified as emerging markets rather
than frontier.
The frontier-markets funds do not have long records;
the oldest ones launched in 2008. They tended
to perform well in 2013 and 2014, but they endured
heavy losses during the late-2007 to early-2009
global financial crisis and badly lagged conventional
emerging-markets funds and indexes in the powerful
rally that followed the end of the bear market. Like
offerings in the other subgroups discussed in this
article, though, they can differ greatly in composition
and performance from one another.
The key marketing pitch for frontier- and frontier/
emerging-markets funds is that these markets are
largely ignored by global investors. That means
promising companies can supposedly be bought at
bargain prices, and the obscurity of frontier markets
means that their performance has even less correla-
tion with developed markets than emerging markets
do. However, those attributes don’t necessarily
make the funds attractive choices. For one thing,
these funds tend to be expensive. Second, few
have long enough track records to inspire confidence
in their management teams and approaches. More-
over, there’s no guarantee that markets at an early
stage of economic development will continue
to grow and prosper. Even if they do, there’s no
assurance that such improvement will translate
into robust stock market gains.
Should investors consider adding a fund from any
of these subgroups to their portfolios? It’s tough to
make a case for the multiasset or frontier-markets
funds. Nearly all of the funds in these subgroups lack
long track records, and high expense ratios further
detract from their appeal. Many in the small/mid-cap
subgroup also suffer from these issues, but there
are a few reasonably priced funds run by seasoned
teams that might be worthy of consideration.
A more persuasive case can be made to explore the
geographically flexible subgroup. Three of these funds
are in the Morningstar 500: American Funds New
World, Oppenheimer Developing Markets ODMAX,
and Virtus Emerging Markets Opportunities HEMZX.
Unlike funds from the other subgroups, a geogra-
phically flexible emerging-markets fund could serve
as an investor’s only emerging-markets choice
rather than as a supplement to a traditional offering.
That said, investors who like to make precise alloca-
tions to various asset classes probably wouldn’t find
these funds suitable, because they wouldn’t know
from one portfolio to the next how much of the assets
will be directly invested in emerging markets. K
Contact Bill Rocco at
and Gregg Wolper at