Funds That Bet on Booming Emerging Markets

NEW YORK (TheStreet) -- Funds that track the MSCI Emerging Markets benchmark have ranked among the most popular investments in recent years. Big members of the group include Vanguard Emerging Markets Stock Index ( VEIEX) and Northern Emerging Markets Equity Index ( NOEMX). By buying the index funds, investors figure that they can place a bet on the booming economies of countries such as Brazil and China where millions of consumers are entering the middle class.

But the MSCI funds may not provide the kind of exposure that investors expect, says Marten Hoekstra, chief executive of Emerging Global Advisors. For starters the index funds don't put all their assets in emerging markets, he says.

According to Morningstar, a quarter of the Vanguard Emerging Markets portfolio is in the developed world. This occurs because the index fund has stakes in South Korea and Taiwan, which are considered developed countries by the International Monetary Fund. Investing in Asian developed countries could produce decent returns, says Hoekstra. But like many developed economies, Taiwan and South Korea are growing at sluggish paces. While such developing economies as India and China have been growing at annual rates of more than 6%, Taiwan has been shrinking and South Korea has been reporting minuscule gains.

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In future years, the growth in the Asian developed countries could remain muted. While emerging economies must spend feverishly to build their infrastructures, Taiwan and South Korea already have modern roads and airports. In addition, there will be no great expansion of the middle class in the developed countries because most people are already prosperous.

Besides holding investments in developed counties, the MSCI funds tend to focus on a few industries, including energy and materials. These sectors have been crucial for enabling countries such as Mexico and Chile to begin their rapid gains. But many natural resources companies are exporters that depend on sales to the developed economies. To benefit from the domestic growth of emerging economies, investors may prefer emphasizing companies in industries such as health, utilities, and consumer staples -- sectors that only play a minor role in the portfolios of the index funds.

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