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What is an Emerging Market Fund?
An emerging market means a country which is rapidly growing in size and scale and is expected to become a developed country soon. The top index provider of the world MSCI has classified 25 world economies as emerging markets. However, the four largest emerging markets globally are India, China, Brazil and Russia. Even though these markets offer higher growth rates, the risk associated is higher too. Also, there are numerous options available for investors seeking to invest in a single country or through a diversified portfolio. Hence, investing through an emerging market fund allows investors to spread the risk by limiting exposure to a single stock or country.
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Emerging market funds are a type of mutual fund that invests most of its assets in securities of developing countries. These funds are equity funds, debt funds or ETFs that invest in emerging market debt or equity to build a diversified portfolio. These funds offer a range of options across risk and attractive investments for growth investors. In other words, emerging market funds seek to capitalise on the return opportunity from the emerging market economies.
In the emerging markets category, investors will have an option for both passive and active mutual funds that provide exposure across countries, sectors and market capitalisation. For example, an emerging market fund may decide on 20% of its allocation towards Russia. Further, it might spread this across banking, auto, petroleum, power, etc. and focus more on large-cap companies in these sectors. Similarly, it can determine the selection for each country. Therefore, this fund offers diversification and an opportunity to earn from the economy’s growth.
Features of Emerging Market Funds
The following are the features of emerging market funds –
Diversification
Since emerging market funds invest in equity/debt securities across developing countries, it offers the investors a great opportunity to diversify their investment portfolio. This also enables investors to take advantage of the market conditions of the emerging markets.
Risk
Since the investment portfolio consists of securities of emerging countries, it always becomes difficult to keep track of the social and economic conditions of those countries. It is also difficult to obtain correct technical knowledge about their market movements. This makes emerging market funds more prone to risk.
Management of money
Since it is crucial to keep track of the movements in the emerging markets, it becomes essential to track these markets on a real-time basis. Hence the fund managers who are professionals having years of experience handle such investments.
Exposure
Emerging market funds invest in equity/debt instruments of various countries, which enable the funds to capitalise on the investment by taking advantage of the changing conditions. This helps them earn from the growth of the economy of these countries.
Advantages of Investing in Emerging Market Funds
Geographical Diversification
The returns on an investor’s portfolio investing in Indian stocks are affected by the performance of the Indian markets. However, adding exposure to these funds increases the geographic diversification in the investor’s portfolio. It also allows the investors to earn from the market cycle of developing countries economies.
Portfolio Diversification
Diversification is key to a sound investment portfolio. Emerging market funds are for higher risk tolerance investors who are looking for portfolio diversification through investment across different emerging markets.
Professional Management
A fund manager can invest the investor’s money in the right places with the help of detailed data, technical expertise and experience in investing in overseas markets. This will help any new investor take an opportunity in emerging markets through an emerging market fund.
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Limitations of Investing in Emerging Market Funds
Risk
Inflation Risk: In emerging markets, fast economic growth often tends to lead to inflation.
Currency Risk: If foreign countries fluctuate against the US Dollar, if the investments are denominated in that currency will also fluctuate.
Liquidity Risk – In many foreign markets, securities trade less frequently. It becomes difficult to buy or sell a few individual securities in such cases. In other words, these markets are not as liquid as developed economies.
Political Risk: Emerging markets tend to have more political instability and political conflicts, adding pressure on the stock and bond market.
Constant Vigilance
Investors need to keep track of different market movements. Any political, social or economic changes in the country can impact the market performance of that country. Subsequently, this can affect fund performance.
Less Information
Fund managers might not follow a foreign company regularly. As a result, investors tend to decide based on information that is not complete.
Who Should Invest in Emerging Market Funds?
Investors must be comfortable with the risks associated with emerging markets. Emerging markets carry a high level of risks and take years to develop. This fund is suitable for investors with a high-risk tolerance for a long term investment horizon. Also, investing in this fund provides diversification in the investment portfolio through foreign markets. Furthermore, investors who have time to study global markets and knowledge of financial instruments and their factors can consider investing in these funds. These funds are ideal for growth investors seeking investment opportunities across global markets in the long term.
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