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Understanding Emerging Market Funds

With their fast-growing markets, countries such as China, Russia and India are a tempting prospect for many investors. On the other hand, many developing foreign countries are politically unstable and new to international investment, making these emerging markets more volatile.

To diversify investments while managing potential risk, many investors opt to invest in an emerging market fund, either an exchange-traded fund (ETF) or a mutual fund. Generally, both ETFs and mutual funds provide highly diversified, low-risk investment options within emerging markets. In addition to looking at the fees associated with fund investments, it's important to consider these characteristics when creating an emerging market investment strategy.

Mutual Funds vs. ETFs

When an individual invests in a mutual fund, the mutual fund manager pools the money with that of many other investors, and then takes this capital to buy securities from a mix of companies in emerging market countries.

Investors should also check to see that the manager of the fund is investing personal money in his or her own fund.

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Mutual funds tend to be extremely diversified, with securities across many regions, industries and companies, says Aaron Dirlam, director of research at Altair Advisers, an independent Chicago-based financial advisory firm. Mutual fund shares can only be traded once a day at the close of the markets, which could be a good choice for individuals who want an actively managed fund but aren't interested in day trading, Dirlam says.

ETFs generally follow the same guidelines as mutual funds but are not actively managed, so the composition of stocks within the ETF will not usually change. "ETFs are more passively oriented, meaning they're looking to buy a consistent basket of securities," Dirlam says.

ETFs can also be more specialized, encompassing only securities from a certain region, and can be exchanged throughout the day like stocks.

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Vetting Emerging Market Funds

Whether investors choose an ETF or a mutual fund, it is important to look at a fund's objectives to ensure it aligns with one's goals, says Gina Beall, lead investment research analyst at Savant Capital Management, a Rockford, Ill.-based wealth management firm. Beall suggests looking at the fund's prospectus - usually available online - which states the fund's objectives, risks and fees.

Foreign investors should also consider a fund's performance over time. "You want to see that managers have [made it] through some of the hiccups - turmoil that emerging markets felt in 2008 and prior," Dirlam says. Some foreign countries that have experienced "hiccups" include Russia in 1998, Brazil in 1999, Argentina in 2002 and a "general" disruption in 2008.

Investors should also check to see that the manager of the fund is investing personal money in his or her own fund, Dirlam says. This information can be found in the fund's Statement of Additional Information.

Determining How Much to Invest in Emerging Market Funds

If an individual is living or working abroad and needs a currency exchange service to convert money for ETFs or mutual funds, it may be wise to use a trusted online foreign exchange provider. An online foreign exchange service can provide relevant resources and insights on currency exchange strategies.

While emerging market funds are becoming increasingly attractive and profitable international investment options, they still carry slightly more risk than traditional domestic market funds, although the gap continues to narrow, Dirlam says.

Dirlam cautions foreign investors about jumping on the emerging market fund bandwagon. Because these funds encompass fast-growing economies, returns can be good, but Dirlam says huge profits are unlikely.  

"Will it beat developed markets or the U.S. by several percent?" Dirlam asks. He thinks so. However, only time will tell.

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