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Risk-Conscious Ways to Make Emerging-Markets Plays

These attractive emerging-markets funds provide a relatively smooth ride.

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Developing countries have enjoyed quite positive economic and demographic trends during the 2000s. Governmental policies and corporate practices have also improved considerably in many emerging markets the past decade. Equity funds that focus on the developing world have capitalized on these favorable conditions. The average diversified emerging-markets fund has earned a 10% annualized gain over the past 10 years, while the typical foreign large-blend, foreign large-growth, and foreign large-value offerings have posted 0.0%, 0.3%, and 2.3% annualized returns, respectively.

Most experts say the economic, demographic, government, and corporate conditions in the developing world will continue to improve for years to come. There are ample grounds, therefore, to be hopeful that diversified emerging-markets funds will produce good returns and outpace foreign large-cap offerings over the long run. (Diversified emerging-markets funds are unlikely to beat foreign large cap by as much over the next decade as they have over the last one, though, as the 2000s were exceptionally poor for most developed-markets stocks.)

All this makes diversified emerging-markets funds enticing, but such funds come with real risks. In fact, they have had a more tumultuous ride than most other categories of funds in 2010--and they were slightly in the red for the year to date through July 16--because worries about inflation in China and Brazil and other concerns have hurt stocks in those two and many other developing nations. Meanwhile, the rough spells have been more severe and somewhat common in the past. These funds lost nearly two thirds of their value in the late 2007 to early 2009 worldwide sell-off, due to anxiety about a global recession and apprehension about valuations and local challenges in many developing nations. And they've been much more volatile over time than all categories of international-stock offerings, except regional emerging-markets funds.

William Samuel Rocco does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.