Forget the BRICs: How to Invest in Emerging Markets

Decoding the BRICs, growth markets, and frontier markets.

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The economist who coined the term "BRIC" is now revising the definition he made famous. (BRICs stands for the rapidly growing countries of Brazil, Russia, India, and China.) Jim O'Neill, chairman of Goldman Sachs Asset Management, singled out the four countries in 2001, but now he's decided to drop the term BRIC. That's because he's adding Mexico, South Korea, Turkey, and Indonesia to the previous BRIC countries, and referring to the group as "growth markets."

Should this new distinction matter to the individual investor? The short answer is no, says William Samuel Rocco, senior fund analyst at Morningstar. "The problem with any of these sort of constructs is that they're limiting," he says. Instead of selecting a fund based on this narrow grouping, Rocco recommends diversified funds that invest across the emerging markets. That way, you can take advantage of growth no matter where it comes from next. But first you should determine how much exposure your portfolio already has to emerging markets, through other stock funds.

[See Why Emerging Markets Belong in Your Portfolio.]

If your portfolio includes a large-cap U.S. stock fund that primarily invests in the big, well-known companies of the S&P 500, you probably already have a bit of indirect exposure to emerging markets countries. An increasing amount of these companies' profits are coming from the growing consumer class in emerging markets like China.

Once you've examined your domestic portfolio, check out your foreign holdings. According to Morningstar, about 12 percent of the holdings in an average foreign large-blend fund—the typical international stock fund for retail investors—are invested in emerging markets countries. If you want more emerging-market exposure than you already have, there are a number of investments—both mutual funds and exchange-traded funds—that can provide it.

Rocco suggests starting with a broad-based, actively-managed fund or a passively-managed index fund that gives you exposure to most of the developing world. Among actively-managed funds, he recommends American Funds New World (symbol NEWFX) and T. Rowe Price Emerging Markets (PRMSX). When it comes to index funds, he likes Vanguard Emerging Markets Index (VEIEX), which gives investors exposure to more than 800 stocks and charges an annual fee of only 0.35 percent.

[See U.S. News's Best Emerging Markets Funds for the Long Term.]

J. Michael Martin, chief investment officer of investment firm Financial Advantage, generally allocates about 20 percent of his clients' money to emerging markets through funds like Aberdeen Emerging Markets (ABEMX) and Wasatch Emerging Markets Small Cap (WAEMX). Small-cap funds can add volatility and diversification to a mostly large-cap heavy portfolio. In 2009, Wasatch Emerging Markets Small Cap returned upwards of 100 percent. (In 2008's downturn, it lost 57 percent, compared with 37 percent for the S&P 500.)

Currently, Martin says he's only allocating about 11 percent of his clients' money to emerging markets funds because he believes they're slightly overvalued. Still, "We think the trends are still very favorable for the developing countries," he says. Martin particularly favors China and South Korea. "In some ways, it's all about China," he says, because growth in China affects Asia as well as emerging economies like Brazil. In 2010, China registered another year of blistering GDP growth, around 10 percent, compared with low single-digit growth in countries like the United States.

ETFs offer even more flexibility to invest in a number of different regions and countries. The two most popular broad-based options are Vanguard Emerging Markets ETF (VWO), which is the same offering as the Vanguard index fund—just in ETF form—and iShares MSCI Emerging Markets Index ETF (EEM). (VWO is a bit cheaper than EEM. Its annual fees are 0.27 percent—about 40 basis points lower.) For more specialized options, Tom Lydon, editor of ETFTrends.com, suggests ETFs that invest in the so-called "frontier markets," which aren't as mature as, say, China and India. "There are a lot of people that missed the emerging markets boom," Lydon says. "The feeling now is, 'Well, there are these new frontier countries that I can buy via ETFs, do I make sure I don't miss the next wave, which may be coming from these frontier countries?'" Options include Guggenheim Frontier Markets ETF (FRN), PowerShares MENA Frontier Countries ETF (PMNA), and SPDR S&P Emerging Middle East & Africa (GAF). The largest holdings in these funds include countries like Chile, South Africa, and Egypt.