3 Choices for Those Expecting an Emerging-Markets Rebound

Investors who believe that the sell-off in the developing world is a buying opportunity will find that they have an abundance of options. Indeed, as we wrote in our recent research paper, “The Growing Complexity of the Emerging-Markets Fund," there now are more than 300 funds in the diversified emerging-markets Morningstar Category (open-end and exchange-traded funds combined). A daunting task faces investors looking over this group. The emerging-markets equity-fund landscape now includes four separate varieties besides the traditional type of portfolio: geographically flexible offerings, small-/mid-cap funds, multiasset offerings, and frontier-markets funds.  

• Traditional funds focus on large-cap stocks and favor the bigger emerging markets. These funds used to be the only choice for investors, and they still compose approximately three fourths of the category. 
• Geographically flexible funds invest not only in typical emerging-markets firms, but also invest significant chunks of their assets in companies that have extensive business in the developing world, but are headquartered in the United States or other developed markets. The first of these funds was launched in 1999, and there now are more than 20 such offerings.   
• Small-/mid-cap funds focus on companies beyond the big, widely owned names. There are approximately two dozen of these funds at present, and all but one of them has opened in the past decade. Multiasset funds divide their assets between emerging-markets stocks and emerging-markets bonds (and in some cases currencies and more). There now are nine such funds, and all of them are less than four years old. 
• Frontier-markets funds target stocks in countries that rank below emerging markets in terms of stock-market access and other factors, such as Colombia, Kenya, Kuwait, Nigeria, and Pakistan. The first of these funds opened in 2008, and there are 15 such funds currently.

Some of the newer funds deserve attention from investors, and we will cover those in a column later this month. For the most part, though, the traditional variety makes the most sense for the majority of investors, so we highlight three of the best ones below. All are Morningstar Medalists. 

 Harding Loevner Emerging Markets (HLEMX) has several strengths. Harding Loevner specializes in international-stock funds and has had significant success across its lineup. Lead comanagers Rusty Johnson and Craig Shaw are veterans of the firm, and they have good credentials as well as a strong support team. Johnson and Shaw follow the same quality-growth strategy as the other Harding Loevner managers have used to earn good long-term results, and that approach provides an attractive combination of upside potential and downside protection. This fund failed to distinguish itself as emerging-markets stocks sold off during the 12 months ended Jan. 27, 2016—it lost 24.5% versus negative 23.6% for its average peer and negative 25.9% for MSCI EM Index—but it held up better than both its typical rival and the index in the 2014 sell-off and in other downturns before that. It generally has performed well in mixed conditions and moderate rallies. It also has good long-term risk-adjusted returns.   

 Invesco Developing Markets (GTDDX) has an exceptionally seasoned and stable management team. Steve Cao and Borge Endresen have served as managers since 2003; Mark Jason worked on the fund for six years before becoming a comanager in 2009; and Brent Bates became a comanager in 2014 after working on the fund for nine years. The managers employ an attractive growth discipline that is fairly conservative as well as rather distinctive. For example, they tend to invest more than most rivals in the smaller emerging markets. Although the fund posted weak results in 2015, it has held up better than most peers in early 2016’s sharp sell-off, as it did in 2011's troubled climate. Thus it still has a sound long-term record. It's also less costly than most other emerging-markets funds.   

Vanguard Emerging Markets Stock Index (VEMAX) ((VWO) for the ETF share class) has an ultra-low cost, which gives it a sizable and enduring edge over the competition, but that’s not the only factor in its favor. Vanguard is a first-rate parent with a long history of treating fundholders well and delivering the goods with index offerings. The team that is in charge here is exceptionally well suited for the task at hand. The fund has done an excellent job of tracking its benchmark over time, and its long-term record is solid. Investors should be aware, however, that its already-large China weighting is getting even bigger as it adds China A-shares to its portfolio. At the end of 2015, the fund had nearly 30% of assets in China, compared with a diversified emerging-markets Morningstar Category average of about 20%.