A good portion of the outperformance of international stocks over the trailing 10 years is due to emerging-markets equities, or stocks of companies domiciled in smaller or less developed markets, such as India, China, or Russia.
Owning emerging-markets stocks has its benefits. First, they can generate robust returns: Over the last 10 years through the first quarter of 2011, diversified emerging-markets funds have blown just about every other fund category out of the water, with an annualized 16% return. Emerging-markets stocks also add more diversity to a U.S. portfolio than stocks from many of the more-developed international markets, such as Germany and the United Kingdom, do. That's because the returns of the U.S. market and other developed markets tend to move in tandem.
There's a price for emerging-markets stocks' exhilarating highs and diversification, though: the threat of steep losses. In June 1998, for example, the MSCI Emerging Markets Index was in a free fall: It had shed 19% in the preceding six months. The developing world suffered currency collapses and soaring inflation, and investors' returns suffered. Then, during the financial crisis of 2008, emerging-markets funds swooned again, dropping over 50% on average, far worse than the S&P 500's 37% drop for the year. If oscillating fortunes make you sweat, limit your search to funds that are light on emerging-markets stocks.
If you're trying to avoid emerging markets, you'll need to be vigilant; after all, most diversified international funds nibble at emerging-markets stocks. In fact, the average fund in the foreign large-blend category held more than 11% of its assets in emerging-markets names in April 2011. Your best bet is to find out which countries a fund frequents. Funds that go shopping in Europe, the U.S., and Japan are focusing on developed markets. But if you see a number of companies from countries in Latin America or the Pacific Region, you'll know that the fund is venturing into emerging markets.
Does It Concentrate in a Specific Region or Country? >>