In 1994 and 1999, Morgan Stanley’s index of emerging markets gained over 60%. Both times, the average diversified emerging markets mutual fund did even better, according to Morningstar Inc., Chicago, with total returns over 70%.
Unfortunately, the rest of the decade wasn’t as upbeat. Emerging markets funds had six losing years in the 1990s and then posted a loss of over 30% in 2000. Despite a strong second quarter (up more than 6%) in 2001, emerging markets funds posted yet another loss (-1%) in the first half of this year, bringing down the three-year annualized return to a measly 0.72%-and that includes a sensational fourth quarter in 1999.
Nevertheless, proponents suggest that there is a place, albeit a small one, for emerging markets stocks in your portfolio. These stocks have only been tracked for around a decade; results since the late 1980s show that a portfolio with a 30% allocation to international equities would have had less risk than an equity portfolio consisting solely of the S&P 500. By market capitalization, emerging markets stocks are around 10% of non-U.S. stocks. These numbers suggest that you might benefit from an allocation to emerging markets somewhere in the area of 5% of your equity holdings.